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Sales Tax on Drop-Shipping: Where New Sellers Go Wrong

author photo of Michael Fleming

We generally receive between 5 & 10 requests per week from new sellers eager to start drop shipping. These sellers want us to get them a resale certificate right away, so they can quickly start drop shipping. It seems like a reasonable enough request, unfortunately, nothing about sales tax is generally that simple. What these sellers actually need will vary from vendor to vendor and there is not a single certificate that will work with all vendors in all situations.

While each state has a resale exemption, what each state will accept to document that exemption is different. If a transaction is not properly documented, it will not be recognized as a sale for resale. To correctly assess what these sellers require, we need to know which states each of their vendors want a certificate for. In the rest of this post, I will attempt to explain why this is important.

In a typical drop shipping scenario, we have three parties and two transactions. In this post, we will use the terms consumer, seller, and vendor to represent the parties. The first transaction is between the seller and the consumer. In this instance, the consumer is the customer. The second transaction is between the seller and the vendor. In this instance, the seller is the customer. We are going to mostly disregard the first transaction and concentrate on the second as this will determine the resale certificates needed.

There are 45 states plus the District of Columbia that have a state-level sales tax. (For the rest of this post we will refer to DC as a state for simplicity’s sake.) Vendors may be registered in one, some or all these states. To determine which state’s rate is charged we need to determine where the sale is sourced. When we are talking about tangible personal property (TPP) we generally look at the state where the product is delivered to the consumer. We call this state the “ship to” state.

TPP is something that can be seen, touched, smelled or otherwise perceived by the senses. It is generally something that can be stored on a shelf and is what many sellers using a dropshipping model sell. We will address digital goods and other types of property in future posts.

Once a vendor is registered to collect sales/use tax in a state they must collect the tax on every transaction delivered into that state, unless they accept a properly completed exemption/resale certificate in lieu of collecting the tax. Please note that the certificate collected must be acceptable to the state where the tax is being charged.

This is where the problem begins. The seller is probably not registered in most of the states they are asking the vendor to ship purchases. So, if the certificate must be acceptable to the ship to state and the seller is not registered in the ship to state, how can the seller provide the correct documentation. Remember that if a sale for resale cannot be properly documented, then the state will not recognize it as a sale for retail. Therefore the vendor is required to charge sales tax if the seller cannot provide a certificate acceptable to the ship to state. In any transaction, drop shipping or otherwise, the nexus of the customer never plays a role in whether a tax should be charged.

The good news is that 36 states will accept some sort of documentation without a seller having to get registered, if the seller does not have nexus. Some states will accept multiple types of documentation and other states are limited. We will share in future posts what each state will accept, but if you need help now, feel free to reach out. (See "Comment or Questions" options below...)

The bad news is that in 10 states (CA, CT, DC, FL, HI, LA, MA, MD, MS & TN) it is most likely that the seller will need to register to collect sales tax to issue a valid resale certificate. Sometimes it may make good business sense for a seller to voluntarily register to collect sales tax in one of these states. Once the seller registers, they will have to collect sales tax but the compliance costs usually pale in comparison to having to pay the vendor sales tax out of their profits.

Summary

The first step in developing a resale certificate strategy is understanding that vendors will generally request resale certificates in multiple states and that there is no one certificate that will work in all states. This does not mean you have to take action in every state, because most vendors are not registered in every state. The best practice is to ask potential vendors where they will require certificates. Once you have this information confirmed, you can start putting together a strategy to satisfy your vendors. If a seller wants to start off registering in just one state, we suggest CA rather than WY. We suggest this because the CA certificate will work in WY but the WY certificate will not work in CA. We also suggest CA because many vendors will need a CA certificate, and it is generally a large volume state for sellers.

In closing, we want to emphasize that each seller's and each vendor's requirements can vary. So it’s very important to consider all options carefully before committing to a strategy – and ideally receive input from a tax professional with multi-state experience. If you have any questions please let us know.

Mike is the founder of Michael J Fleming & Associates (dba Sales Tax and More). Prior to beginning this new venture, Mike spent the better part of a decade as a Director with Peisner Johnson, an accounting firm that is focused entirely on solving state and local tax issues. Mike’s state tax knowledge is well rounded, but he is one of the country’s leading authorities when it comes to eCommerce, nexus, service providers, and drop shipping.

Comments or questions may be submitted by using the on-page "Comment" feature, subject to disclaimer at bottom of page. More specific questions or requests may be sent to Mike directly using the orange REQUEST link on his Firm Profile page.

Other recent “Drop Shipping” posts by Michael Fleming:

NOTE: All blog content, comments, and participation subject to disclaimer at bottom of page.

Comments

21 Responses to Sales Tax on Drop-Shipping: Where New Sellers Go Wrong

  • Posted by Linda on July 24, 2018 1:49pm:

    Hello. Our WI customer placed an order with us (we're in CA). We drop shipped the order from a vendor also located in WI. The vendor charged us tax. Is this correct? This is a non-taxable order for our customer. The WI vendor tells me I need a WI Exemption Certificate. Is this correct?

    • Posted by Author photo of Michael Flemingmichaeljfleming on July 24, 2018 6:36pm:

      A seller is always required to collect sales tax or a certificate in lieu of sales tax on every sale of a taxable item/service from their customer in the delivery state. In your example, the vendor is the seller and you are their customer. So yes, your vendor should be asking you for a certificate or charging you the tax

      However, WI is a member of the SSUTA and will accept the SSUTA F0003 multijurisdictional certificate with your home state number.

  • Posted by Bob on July 4, 2018 10:56am:

    My company provides information, drawings and photos digitally to insurance adjusters and carriers to be used to supporting decisioning around claims or underwriting.

    We don't provide the insured this information directly though it is easy to assume that the insured's location determines nexus. Though not a drop ship it seems to have all the characteristics of a resale.

    Of course the carrier may not sell a policy and a claim may not be paid; still do we need to be concerned about registering and/or collecting sales taxes?

    • Posted by Author photo of Michael Flemingmichaeljfleming on July 5, 2018 5:31pm:

      Hi Bob,

      Sales to a provider of a non-taxable service are generally taxable to the service provider. The service provider is generally considered the consumer of products used in the provision of a service. The items you describe are not being resold to the insured, but are used by the insurance adjuster or underwriter to perform their service.

      So if you have nexus in the state where your sales are sourced and if the state taxes your products/services you would generally be required to register, collect, and remit sales tax, unless there is another exemption available to your customer.

  • Posted by alfred on July 3, 2018 11:40am:

    Hello,

    We are the Vendor selling an order to a Seller based in AZ. This is a drop shipment shipping from our CA warehouse to Consumer located in TN where we also have a warehouse located. Seller doesn't have nexus in TN. Are we responsible to collect the Sales Tax from the Seller?

    Alfred

    • Posted by Author photo of Michael Flemingmichaeljfleming on July 3, 2018 11:51am:

      Hi Alred,

      Yes, unless your customer's customer is exempt in which case your customer could pass through their exemption. This is rare but is acceptable.

      Otherwise, a seller is required to collect sales tax or a certificate in lieu of the sales tax anytime the delivery address is in a state the seller is registered.

      Whether the customer has nexus or not is immaterial. In most states, the customer could provide some sort of documentation using the AZ number, but TN is one of the 10 tough states where the reseller must be registered to issue a valid resale certificate.

      So if your customer is not registered to collect tax in TN, they can not issue a valid resale certificate and you are required to collect the tax from them.

      Mike

      Mike

  • Posted by Tina on June 22, 2018 7:02am:

    My business is located in Plainfield IL. We are buying product out of state as a reseller and having it drop shipped to Naperville, IL. What sales tax does the customer in Naperville IL pay? Our sales tax in Plainfield or the sales tax in Naperville?

    • Posted by Author photo of Michael Flemingmichaeljfleming on June 23, 2018 9:18pm:

      Hi Tina,

      There are a number of factors that go into determining where a sale is sourced for local sales tax and we don't know all of those factors for your situation, but based on what you shared it is most likely the Plainfield Il, address. we assume that the orders are accepted at this address invoices issued and payments received. we also assume this is where your HQ is. Location of where the inventory is a factor, but the sales are generally sourced where three or more of these factors are located.

      Mike

  • Posted by Annette on June 20, 2018 10:43am:

    Hi Mike

    What about VA will they still accept their VA certificate with what ever state out customer maybe located in with their home state information?

    Thank You

    • Posted by Author photo of Michael Flemingmichaeljfleming on June 20, 2018 11:08am:

      Hi Annette,

      Yes, Virginia will still accept a home state number on the VA certificate. The state doesn't make it appear so, because there is no official place to write the home state number like on other certificates. It may look a little messy- but you can insert it on the certificate where you can. I usually suggest adding No nexus in VA. My home state is ___ and my number is ______.

      Mike

      • Posted by Annette on June 20, 2018 12:55pm:

        Thank You Mike you ROCK

  • Posted by John on June 18, 2018 2:10pm:

    Hi Mike,
    I'm currently working with a vendor to purchase goods for resale. They have indicated that they have Nexus in all 50 states and I have CA seller's permit and have provided it to them. They are now requiring me to apply for certificates in CT,DC,FL,HI,MD,MA,MS,TN,NY and VA or they will charge me sales tax if the end consumer is in those States. I know I'm required to charge sales tax in CA but am I required to charge sales taxes in the other states that my vendor has approved to not charge me sales tax? If I do get certificates/permits in the states my vendor is requesting will I need to charge sales tax?

    • Posted by Author photo of Michael Flemingmichaeljfleming on June 18, 2018 3:29pm:

      Hi John,

      There are 10 tuff states where you could or will have to be registered to issue a valid certificate depending on your vendor's circumstances. CA is the first of these states followed by CT, DC, FL, HI, LA, MD, MA, MS, & TN. Looks like they do not have a warehouse in LA, so you lucked out. If they had a warehouse in LA they probably would have asked you to register there also.

      In the 8 "tuff" states, they asked you to register, it may or may not make sense to register depending on your volume with that vendor in that state. If you only have a coulple sales a year, or even month it may make sense to just pay the tax to the vendor rather than register to collect and remit the tax, especially if you have a lot of sales into the state from other vendors not charging you the tax. Hlowever, if your volume is large, voluntarily registering generally makes sense, because teh cost of compliance is generally less than the tax you would pay on a bunch of sales. IN HI by the way you would still pay tax if you register only it would be 1/2 percent rather than 4%.

      I am not sure wht they are asking you to register in NY & VA. Both of these states allow the use of your home state number, although both require their state specif form. In NY you would skip section one and fill out sction two. Section onw is for companies with nexus an/or who are registered, while section two is for those companies that don't have nexus and are not registered. The form asks for the state and pemit number where you are registered. Virginia is not as neat. You have to write in that you don't have nexus and provide your home state and number.

      If your vendor thought you had nexus in these states that may be why they want you registered or perhaps they don't understand what they can accept. Even large companies have problems with drop shipping documentation. Or maybe they just worded their request awkwardly adn jsut want the state specific certificates completed as I mentioned.

      My suggestion is to specifically ask why they say you need to be registered. We can then discuss their response in this forum orr offline. If the dollars involved are material, we can provide you and.or your vendor with a write-up documenting why you don't need to register. We also can get on a three way call and discuss.

      But the first step is to findout why they are making the request in NY & VA. In the other states it will come down to a business decision as what you beleive is best.

      Mike

      • Posted by john on June 18, 2018 4:18pm:

        Ok. So the states that the vendor is not requesting permits/certificates, am I required to collect taxes for each state? For example they are allowing me to use my CA seller's permit to buy and sell to a buyer in Nevada. For example if they have a warehouse in Nevada and ship to the buyer in Nevada where they have Nexus. Would I charge sales taxes to the Nevada buyer and report?

        • Posted by Author photo of Michael Flemingmichaeljfleming on June 18, 2018 5:06pm:

          No - drop shipping or the use of a certificate does not generally create a requirement to collect tax. It's all about properly documenting a sale for resale. If a transaction is not documented properly the state will generally not recognize the transaction as a sale for resale. NV is one of the 36 so-called "easy" states. These states have some flexibility in what they will accept to document the sale. In NV your vendor is accepting either your CA certificate or your CA number.

          This relieves the vendor from having to collect sales tax from you. Since you do not have nexus in NV you do not have a responsibility to collect the tax. So in this scenario, your customer would be responsible for self-assessing and remitting the tax directly to the state. Whether they do or not has no impact on you as you do not have a responsibility to collect the tax.

          Even in the tuff states, you don't have a responsibility to collect the tax. These states just want You to be registered for a certificate to be valid. So collecting the tax is not mandatory but a choice.

          • Posted by john on June 18, 2018 9:33pm:

            Thanks for the info Mike.

  • Posted by Shane on June 15, 2018 1:07pm:

    Hey Mike - of the states who do not accept exemption documentation from another state, how many of them will accept the end-customer's certificate? (like the scenario you mentioned in comments above for Cali)

    Thank you, I hope things are going well. Shane Ratigan

    • Posted by Author photo of Michael Flemingmichaeljfleming on June 15, 2018 1:36pm:

      Hi Shane,

      Great question. I generally look at CA, CT FL, MA and TN as allowing the certificate to be passed through and DC, HI, LA, MD & MS not allowing it to be passed through.

      By the way, HI is a little different than the other states. A tax is still due when a certificate is provided, but the transaction will be at the 1/2 percent wholesale rate rather than the 4% retail rate.

      Things are going great and we are up to speed much quicker than I anticipated.

      Mike

  • Posted by Debbie on June 11, 2018 12:51pm:

    Will CA let us do a pass-thru and charge our customer a sale tax reimbursement to offset what we are paying in taxes for the sale?

    • Posted by Author photo of Michael Flemingmichaeljfleming on June 11, 2018 5:06pm:

      Hi Debbie,

      CA does allow a pass-through, but I am not sure if that is what you are actually asking about. If your customer is purchasing for resale or is exempt for some other reason, CA will allow you to collect a certificate from your customer and provide it to your vendor. In other words, your customer's exemption is passing through you, to your vendor. A "pass-through". in this case no tax would be collected. This is rare and a transaction does not generally qualify for this treatment.

      In most states, the preferred way to recoup the tax you paid is to increase your sales price. However, there are some states, CA included, that allow you to add specific language to an invoice where you can recoup the amount of tax paid to your vendor from your customer.

      The language cannot simply say California Tax or California Sales Tax. This is not allowed and can end up resulting in a case of tax collected and not remitted, which is the cardinal sin of sales tax.

      You can say something along the lines of "Reimbursement of California tax paid to California drop shipper" This is not always easy to add to an invoice correctly, especially when sales volumes are high. Some sellers also care that this is a red flag that you are selling someone else's inventory.

      Most sellers who have a decent amount of sales into CA generally choose to register to collect sales tax voluntarily. This way they can give their vendor a valid resale certificate and don't have to worry about paying their vendor tax, adding extra language to their invoice or having to deal with CA if CA does not like the language added to the invoice.

      The cost of compliance is usually less than the tax paid to the vendor or the headaches of adding the extra language.

      If you are first starting out or have low sales to CA from vendors wanting a resale certificate, we suggest either paying the tax or using the exact language we included above.

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