Sales Tax Q&A: Drop Shipping

We field a lot of interesting questions about different sales tax scenarios. This one deals with drop shipping—a particularly challenging situation that causes much confusion for vendors all along the supply chain.

We're a manufacturer, what is our tax responsibility on drop shipments made by our customers to their customers?

Great question! The core of the answer involves nexus — a connection between a business and state that obligates a business to collect sales tax. There are a number of possible scenarios:

1. In states where your company has nexus, you are obligated to collect sales taxes or accept a valid resale or exemption certificate when you make a sale. (We'll assume all the items you sell are taxable in all places for the sake of your question.)
2. In states where your customer (the "vendor" from here on out) has nexus, the vendor is already obligated to collect sales taxes on their sales. Since they are registered in those states, they can give you a valid resale certificate.
3. In states where your company and the vendor both lack nexus, no one is obligated to collect (though users are technically obligated to pay it).
4. When the retail customer is located in states where your company has nexus but the vendor does not have nexus, it gets complicated. We’ll focus on this situation.

Some states allow you to accept a resale certificate from a foreign state: the vendor gives you a valid resale cert from their state and you accept it as proof of no tax on the sale to the vendor. The majority of states will allow this, either via the vendor's home state certificate or via the MTC multi-state exemption form.

However, some states do not allow a registered seller to accept a resale certificate from another state. In these states, a drop shipper is obligated to collect on either the amount billed to the vendor (wholesale price we presume) or on the amount the customer pays (retail price).

The problem is that many wholesale vendors do not know the final retail price. A few states provide rules on how to establish the tax base for transactions when the retail price is unknown, but it’s still a challenge.

There are other complicating factors. For example some states (like California) allow foreign resale certificates but generally do not accept foreign exemption certificates. Also, some states that do not allow acceptance of a foreign certificate will allow a drop shipper to accept a foreign certificate proffered by the retail customer, even though the sale is technically made between the drop shipper and the vendor.

Figuring out how sales tax applies to different drop shipping scenarios is made more difficult because many state's published rules don't describe the drop-ship specific fact pattern in detail. The only certainty is that states vary in their treatment of drop shipping sales tax.

For a good primer on the challenge of drop ship sales tax compliance, check out the drop shipping webinar in our thought leadership series.

Still confused? Check out the drop shipping section in our Q&A forum. If you don't see what you need, ask a question!