The small business guide to shipping charges and sales tax
For many small businesses, remote sales offer the opportunity to target customers all over the country and simply ship the orders to those customers. But shipping does present its challenges, and sales tax is part of that. The rules for collecting sales tax on shipping charges can be complicated and they different for each state, which adds to the complexity.
However, it’s especially important for small businesses to get sales tax right; most small businesses can ill afford the audits, penalties and fines that can result from noncompliance. This whitepaper offers guidance on what to watch out for when it comes to sales tax and shipping.
Getting nexus right
As always, knowing your nexus is the first step in sales tax compliance, and shipping costs are no different. If you have nexus in a state, and that state taxes shipping costs, then you will be required to collect sales taxes on those orders.
Showing sales tax on invoices
Listing shipping charges separately on invoices from the price of goods being sold can be important for sales tax. This is because some states do not tax shipping costs as long as they are listed separately from the price of the item. However, some states tax both the item price and shipping costs. These guidelines apply to shipping costs for common carriers, such as USPS, UPS or FedEx. Delivering the goods yourself may have different sales tax implications.
The following states tax shipping costs when they are part of an order, regardless of whether the shipping charge is part of the price of the item or listed separately.
Arkansas, Connecticut, District of Columbia, Georgia, Hawaii, Illinois, Indiana, Kansas, Kentucky, Michigan, Minnesota, Mississippi, Missouri, Nebraska, New Jersey, New Mexico, New York, North Carolina, North Dakota, Ohio, Pennsylvania, Rhode Island, South Carolina, South Dakota, Tennessee, Texas, Vermont, Washington, West Virginia and Wisconsin.
Meanwhile, the following states do not tax common carrier shipping costs as long as the shipping cost is shown separately from the price of the item.
Alabama, Arizona, California, Colorado, Florida, Idaho, Iowa, Louisiana, Maine, Maryland, Massachusetts, Nevada, Oklahoma, Utah, Virginia and Wyoming.
Several of these states have special conditions and restrictions that can make the taxability of shipping costs more complex. Some examples include:
• In the case of Florida and Louisiana, shipping is not taxed as long as the amount is shown separately on an invoice and the charge can be avoided by an option such as picking up the item rather than having it shipped.
• In Idaho, Louisiana, Maine and Utah, if a seller orders an item from the manufacturer for a customer and then ships it to the customer, the cost for shipping to the seller, if passed on to the customer, is taxable. If the seller orders the item on behalf of the customer and the manufacturer ships it directly to the customer, however, the shipping cost is not taxable.
• In Maine, Maryland and Virginia, shipping charges must be shown separately on the invoice, and they must also be separated from handling fees. If shipping charges are bundled together with handling fees, then the whole combined charge will be taxable.
• However, in Oklahoma, both shipping and handling charges are nontaxable, as long as they are listed separately on the invoice.
• In Wisconsin, if a package includes both taxable and nontaxable items, only shipping charges for taxable items are subject to sales tax.
Drop shipping — in which a seller orders an item on behalf of the customer and has it shipped directly to the customer from a third party — can be beneficial business model. Particularly for small businesses, drop shipping can solve inventory and logistics challenges while keeping customers happy.
However, drop shipping can make sales tax compliance complicated. A drop-shipping scenario is essentially two transactions: a (generally) tax-exempt wholesale sale from the shipper to the seller, and a taxable sale from the seller to the end customer. States want to make sure that any sales tax due on any part of the transaction is collected.
It’s crucial for sellers to be aware of state rules in drop-shipping situations and to work together with shippers to make sure compliance requirements are met.
When neither you nor the shipper have nexus
If neither you (the seller) nor the shipper have nexus in the state where the sale is made, neither of you has an obligation to collect sales tax and it is up to the customer to pay use tax on the transaction.
When you have nexus
When you are drop shipping an order to a customer in a state where you have nexus, you are required to collect sales tax, just as you would with a non-drop shipment.
When you don’t have nexus but the drop shipper does
Several states consider a shipper with nexus in that state responsible to collect sales taxes when the seller lacks nexus, including California, Connecticut, Florida, Hawaii, Massachusetts, Nebraska, Nevada, Rhode Island and Tennessee.
In these cases, the shipper may fulfill that obligation by collecting the sales tax from you, the seller. In order to avoid paying this tax, you may be required to produce an exemption certificate.
In most states, sales taxes are only levied on retail sales, not sales for goods that will be resold. An exemption certificate authenticates that the transaction is tax exempt.
Resale exemption certificate procedures are individual to each state. Many states will accept an out-of-state resale certificate, multi-jurisdictional form or alternate documentation in a drop-shipping situation.
Creating nexus with drop shipping
However, in states that don’t accept these types of exemption certificates, things can get even more complicated for the seller. For example, in California and other states that have stricter requirements for resale certificates, a seller may have to register with the state in order to provide a valid exemption certificate. By registering, the seller would now have nexus and be obligated to collect sales taxes from customers in that state.
And in some states, simply using a drop shipper can create nexus for the seller, including California, Florida, New York and Texas.
Shipping sales tax solution
When it comes to sales tax on shipping costs, each individual state has its own requirements and the more states you deal with, the harder it can be to keep up with everything you need to know. Drop shipping can make compliance even more complicated. But it’s crucial for small businesses to make sure they are following these rules. Negative consequences resulting from noncompliance can be overwhelming for small businesses with limited resources.
One tool that small businesses can use to make sure they get shipping cost sales tax right is automation, such as the Avalara’s AvaTax software. Automation can help you make sure you’re charging the correct sales tax rates every time on both sales and shipping charges. AvaTax’s accuracy is 100% guaranteed, so you can be sure that you’re getting sales tax right no matter how your products are getting delivered.