Who Pays Sales Tax on Drop Shipments?

When a customer orders an item online that is shipped directly from a third-party supplier rather than the seller, it’s known as a drop shipment. This multi-party transaction introduces complexities in determining sales tax responsibilities. Understanding sales tax obligations in a drop shipment scenario is crucial for compliance, as it involves multiple entities and differing state regulations.

Understanding Drop Shipments and Sales Tax Principles

A drop shipment typically involves three distinct parties: the customer, the vendor (the retailer who takes the customer’s order), and the shipper or supplier (the entity that ships the product directly to the customer). Two transactions occur: the sale from the supplier to the vendor, and the subsequent sale from the vendor to the end customer. Sales tax is generally a consumption tax imposed by government authorities on the sale of goods and services.

A fundamental concept in sales tax is “nexus,” which describes the connection a business has to a state that obligates it to collect and remit sales tax. Nexus can be established through a physical presence, such as having a store, office, or employees in a state. It can also arise from economic activity, known as “economic nexus,” where a business meets a certain sales volume or transaction count threshold within a state. The other guiding principle is “destination-based” sales tax, meaning the tax rate is determined by the location where the goods are received by the customer. Most states in the United States operate under a destination-based sales tax system.

Sales Tax Obligations of the Vendor

The vendor, who directly sells to the end customer, generally bears the primary responsibility for collecting sales tax. This obligation arises if the vendor has sales tax nexus in the customer’s state. If the vendor maintains a physical presence or meets the economic nexus thresholds in the state where the customer receives the goods, they are required to register with that state’s tax authority and collect the applicable sales tax.

If the vendor does not have nexus in the customer’s state, they typically do not have a direct obligation to collect sales tax. However, this absence of collection does not necessarily mean no sales tax is due on the transaction, as other parties or the customer might have a use tax obligation. The vendor’s nexus status in the destination state is a determinant of their direct sales tax collection duties.

Sales Tax Obligations of the Shipper

The sales tax obligations of the shipper or supplier in a drop shipment scenario depend significantly on their nexus status and the provision of a valid resale certificate. When a supplier ships goods directly to an end customer on behalf of a vendor, the transaction between the supplier and the vendor is generally considered a wholesale transaction for resale. This transaction should typically be exempt from sales tax to avoid double taxation.

To facilitate this exemption, the vendor should provide the shipper with a valid resale certificate. A resale certificate is a document that allows a retailer to purchase products without paying sales tax, with the understanding that these products will be resold. By receiving a valid resale certificate, the shipper is relieved of the responsibility to collect sales tax from the vendor on that particular transaction. The shipper must keep this certificate on file as proof of the tax-exempt nature of the sale.

If the shipper does not receive a valid resale certificate from the vendor, and the shipper has nexus in the state where the goods are delivered, the shipper may then be obligated to collect sales tax from the vendor on the wholesale price of the goods. Some states permit acceptance of out-of-state resale certificates, or a multi-state exemption form, while others may require the vendor to be registered in the destination state to issue a valid certificate. The presence or absence of a proper resale certificate directly impacts the shipper’s requirement to collect tax from the vendor, highlighting its importance in managing sales tax compliance for drop shipments.

State-Specific Approaches to Drop Shipment Taxation

Sales tax rules governing drop shipments vary considerably across different states. There is no single federal rule, and each state establishes its own definitions of nexus, sales tax rates, and specific requirements for drop shipment transactions. This jurisdictional variation means that what is compliant in one state may not be in another.

Many states generally hold the vendor responsible for collecting sales tax if the vendor has nexus in the customer’s state. However, some states have specific provisions that can shift or share the sales tax obligation. For instance, some state laws may require the shipper to collect sales tax from the vendor if the vendor is not registered in that state and does not provide a valid resale certificate, assuming the shipper has nexus in the destination state. Other states might accept an out-of-state resale certificate, while a few could require the vendor to register in the destination state to issue a valid certificate. Given these variations, both vendors and shippers involved in drop shipment activities must actively research and understand the specific sales tax laws and regulations in every state where they conduct business or have nexus. This diligence is crucial for maintaining compliance and avoiding potential liabilities.