The short answer is probably yes. However, the regulations are complicated, and different for every state.
What Is Drop Shipping?
This arrangement allows you to avoid the costs of warehousing and labor of shipping your inventory to customers. Here’s how it works:
1. The customer orders an item from you.
2. You order the item from the manufacturer or wholesaler.
3. The manufacturer or wholesaler ships the item directly to your customer.
How Does Drop Shipping Change Your Tax Obligations?
As you know, whether or not you have to collect sales tax on items sold to customers residing in a particular state depends on whether you have nexus in that state.
Each state has its own definition as to what constitutes nexus, including the possession of a brick and mortar facility, the presence of sales reps in the state, or even advertising in media viewed in the state. If you have nexus, then you’re obligated to register with the state, collect sales tax, and remit it to the state’s tax authority.
Bear in mind that last year’s Supreme Court decision in the case of South Dakota v. Wayfair means that a retailer’s physical presence in a state is no longer required as part of the tax nexus. So you can pretty much assume that you’ll be dealing with sales tax in every state where you have customers.
Drop shippers are likely to have their own sales tax nexus, depending on where they’re located. So if you don’t have nexus and the shipper does, who’s responsible for collecting the tax?
It should be the retailer; after all, it’s a retail sale transaction between the retailer and the final customer. However, a few states will require the drop shipper to collect the tax. This can turn into a big mess if the drop shipper is located in another country, such as China.
Furthermore, if neither the retailer nor the drop shipper has nexus, the customer is still responsible for paying use tax. For those cases, you’ll have to submit documentation to both the state and the customer.
What About Resale Certificates?
If you want to avoid paying sales tax on the goods you purchase from manufacturers or wholesalers, you must apply to every state where you sell the goods for a resale certificate. Then you simply provide this document to your suppliers.
This is also true of merchandise that is drop shipped. So what do you do if you aren’t registered to sell in a state where you don’t have tax nexus?
Most states will still issue a resale certificate. Some will accept the retailer’s home state certificate, or add that certificate’s registration number to their own certificate. Others will accept a comprehensive certificate such as the Multistate Tax Commission (MTC) Exemption Certificate or the Streamlined Sales Tax Exemption Certificate.
However, about 10 states require you to qualify for their own resale certificate. Plus, there’s always the question of whether your supplier will accept any document other than a state resale certificate.
You can see why we recommend that retailers register in every state where they have customers, nexus or not. It might seem like a hassle up front, but it will save you even more hassle in the long run.
At Xendoo, we specialize in helping small businesses navigate the complex tax regulations that can be so frustrating, preventing you from putting your best efforts into growth and profit-making activities. When you sleep well at night, we’ve done our job right.