How Does Drop Shipping Relate to Sales Tax?

Drop shipping is a situation in which a retailer sells products which are physically inventoried with a 3rd party in a warehouse or distribution center.

When an order is placed, the retailer connects with the third party and arranges shipment to the customer. Although this is technically two transactions, the experience remains seamless for the customer. Often times retailers do not have the space to keep large inventories and utilize drop shipping as a way to cut back on costs, but drop shipping can also be a nexus creating activity as it relates to sales and use tax, particularly if all three parties are located in different states. What happens when the retailer is not registered to collect drop shipping sales taxes in the ship to state?

Nexus is a physical presence and can include a number of different situations such as warehouses, stores, affiliates, trade shows or even salespeople, which triggers a drop shipping sales and use tax obligation requiring retailers to register for, collect and remit sales and use taxes. Drop shipment rules by state vary. What constitutes nexus varies by state and jurisdiction so it is important to seek the advice of your trusted tax advisor when determining where you have nexus.

In drop shipping scenarios it is important to determine which party has the sales tax obligation, and for which location they should be charging sales tax. It is also essential to figure out which resale certificate can be issued by the retailer, so that the state is satisfied, the vendor protected and the sale treated as a sale for resale.