Dropshipping and Sales Tax

Dropshipping is an increasingly common e-commerce business model and a great way to ensure customers get the items they need, even if you don’t have them in stock.

But figuring out who charges sales tax in a dropshipping situation can turn something fairly simple into a huge headache. Let’s look at how dropshipping and sales tax work.

What Is Dropshipping?

In an e-commerce scenario, you, the Retailer, sell an item to a Buyer. There are only two parties involved. In this scenario, as long as you have sales tax nexus in the Buyer’s state, it’s your responsibility to collect sales tax from the Buyer.

Dropshipping includes three (or more!) parties in a single transaction.

The most common dropshipping scenario occurs when you, the Business Owner, receive an order for an item from a Buyer but don’t actually have that product in stock. Instead, you buy the item from your vendor, the Supplier and Shipper, and then have the Supplier ship the item directly to the Buyer.

How dropshipping taxes are treated in this scenario depends on which jurisdictions are involved in the transaction and where the parties involved have sales tax nexus.

Do You Need to Charge Sales Tax When Dropshipping?

Because three (or more) parties are involved in a dropshipping transaction, the answer to “who collects the sales tax?” isn’t always obvious. 

However, the bottom line is that if a tax is imposed on a transaction, the state is owed the sales tax. If the items sold are taxable, somebody has to collect and/or pay that sales tax.

When using the dropshipping business method, the entity that collects the sales tax and remits it to the state can be any one of three parties: the Retailer, the Supplier, or the Buyer. 

So, for every dropshipping transaction, your business needs to make some determinations: 

1. You must determine if you, the Retailer, and/or your Supplier have sales tax nexus in the state where the order is sourced. (Sourced is just a fancy sales tax way of saying “to where the item ships.”)
2. If you, the Retailer, have sales tax nexus in the Buyer’s state, you must determine how much sales tax to collect and then collect it from the buyer.
3. If you don’t have sales tax nexus in your Buyer’s state but the Supplier does, they must either receive a Resale Certificate from you or determine how much sales tax to charge you. (Remember, you are buying the item from them to ship to your customer.)

How to Determine if You Have Sales Tax Nexus in a State

There are several ways to establish sales tax nexus in a state, but the two most common are physical nexus and economic nexus.

Physical nexus is established when you have a physical presence in a state, such as property, like an office or brick-and-mortar store. Other things that can establish physical nexus are having employees in the state and inventory, including inventory controlled by a marketplace facilitator.

On the other hand, economic nexus is created when a business has no physical presence in a state but meets or exceeds a state’s economic nexus threshold. This is usually $100,000 in sales and/or 200 transactions. Economic nexus is relatively new and was established in the US Supreme Court case of South Dakota vs. Wayfair in 2018.

Four Common Dropshipping Sales Tax Scenarios

Find your own sales tax scenario here to discover how to handle sales tax with dropshipping.

A quick refresher:

• Retailer - the store ostensibly selling the product to the Buyer
• Supplier - the store where the Retailer buys the product that will be sent to the Buyer 
• Buyer - the purchaser who will use the product
• Resale certificate (AKA exemption certificate) - A document that allows a Retailer to purchase products without paying sales tax as long as they plan to resell those products 

Scenario 1: Neither the Retailer nor the Supplier has sales tax nexus in the Buyer’s state

This is one of the simpler dropshipping scenarios. In this case, both the Retailer and the Supplier are not required to charge sales tax on the product. Instead, the Buyer is required to pay use tax to the state (generally filed as part of their state income tax return).

Example: Jess (Buyer), who lives in North Dakota, purchases her favorite Colorado-based basketball team’s branded water bottle from an online store (Retailer). But the Retailer dropships water bottles from a water bottle manufacturer in Kentucky (Supplier.) In this case, neither the online Retailer nor the Kentucky-based Supplier have sales tax nexus in Colorado, they are not required to charge sales tax to Jess on her water bottle. Instead, Jess should pay use tax on her North Dakota state income tax return.

Scenario 2: Retailer makes a dropshipping sale to a customer in a state where the Retailer has sales tax nexus, but the Supplier does not

In this case, the Retailer is required to collect sales tax from the Buyer, as they would in any other e-commerce transaction. But because the Supplier doesn’t have sales tax nexus in the Buyer’s state, they are not obligated to collect sales tax nor a resale certificate from the Retailer, even though it is the Retailer who ultimately pays them for the product. 

Scenario 3: Retailer makes a dropshipping sale to a customer in a state where both the Retailer and Supplier have sales tax nexus

In this scenario, both the Retailer and the Supplier are obligated to collect sales tax. In this case, the Supplier should collect sales tax from the Retailer unless the Retailer can provide the Supplier with a resale certificate. A resale certificate allows the Supplier to sell to the Retailer tax-free since the Retailer will then go on to resell the product to the Buyer. 

What happens if the Retailer does not provide a resale certificate or if, for some reason, the Supplier chooses not to accept it? 

For this transaction, the Supplier will charge the Retailer sales tax on the purchase of the Product. The Retailer is obligated to collect sales tax from the Buyer, too.

In this case, the Retailer will collect and remit sales tax from the buyer. However, the Retailer can request a credit on their state sales tax return for the sales tax they paid to the Supplier. 

Scenario 4: Retailer makes a dropshipping sales to a customer in a state where the Retailer does not have nexus, but the Supplier does have nexus

In this scenario, the Retailer is not required to collect sales tax from the Buyer, but the Supplier is required to collect sales tax from the Retailer. This is because sales tax is sourced to the Buyer’s ship-to address and the Supplier has an obligation to collect sales tax on sales to the buyer’s state.

For this transaction, the Retailer is not required to collect tax from the Buyer, but the Supplier is required to collect sales tax from the Retailer. Because the Retailer is purchasing the product from the Supplier for resale, they can provide the Supplier with a resale certificate to avoid paying sales tax.

If, for some reason, the Supplier will not accept the Retailer’s resale certificate when fulfilling customer orders, the Retailer can request a credit on their next sales tax filing.

What to Know About Dropshipping and Resale Certificates

In an ideal world, a Retailer would always be able to provide their dropshipping Supplier with a resale certificate and have it readily accepted.

But resale certificates can be tricky. For one, ten states do not allow any vendors to accept an out-of-state resale certificate. California is one such state. In order for a Retailer to buy items for resale from a California vendor, they require that the Retailer be registered for a California sales tax permit. 

If you, a Retailer, are not based in California and do not have sales tax nexus there, then you may not be registered to collect and file sales tax in California. But this also means that California vendors can’t accept your resale certificate. So if you make a purchase from a Supplier located in California then that supplier will not accept your resale certificate… unless you register to collect and pay sales tax in California. 

As a Retailer, it’s up to you to determine if using a California-based dropshipper is worth the time and effort of complying with California sales tax laws. If you do decide to sign up for a California sales tax permit in order to take advantage of buying items tax-free for resale from California vendors, just remember that this means you’re also now obligated to collect sales tax from all California customers.

Simplify Dropshipping and Sales Tax: Conclusion

There are no straightforward rules and regulations regarding sales tax for drop shipments. It depends on a variety of factors, such as whether you have nexus or other sales tax obligations in a state. Regardless of the situation, it’s important that you understand the tax rules of where you’re operating and that you’re compliant.

Working with a tax professional or using an automated sales tax solution is the best way to ensure sales tax compliance. Zamp gives you both! 

We’re the first managed sales tax solution on the market, allowing you to outsource your sales tax compliance from start to finish. We provide a streamlined sales tax experience, handling nexus tracking, registrations, filing, and more. Our software seamlessly integrates with your Shopify, Amazon, Etsy storefront, and more.

Dropshipping Sales Tax: FAQ

Do I need a sales tax ID to dropship?  If you are selling items at retail then you are required to register for a sales tax permit and collect sales tax in states where you have sales tax nexus. (This includes your home state, but also states where you have a location, employee, or other business activity, such as economic nexus.) Learn everything you need to know about US sales tax here.

How does dropshipping work when my Supplier is not in the US? Dropshipping still works the same. If your Supplier is not in the US and has no sales tax nexus in the US state where your Buyer is located, then you’d still treat this transaction as Scenario 1 or 2 above.