Drop Shipping and the Manufacturer, Wholesaler, Retailer – A Sales Tax Nightmare

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Most would agree that the administration of drop shipments is currently one of the most challenging sales tax scenarios to deal with.  Not only does drop shipping affect the manufacturer, but it can also have an adverse effect on wholesalers, distributors, retailers, and even end users.  To fully understand the taxation of a drop shipment, one must first understand what a drop shipment is and look at the logistics of the transaction.

What is a Drop Shipment?
A drop shipment occurs when a customer orders an item from a seller that is not in stock.  The seller in turn orders the good from another business (which is usually a manufacturer, but not always) and has them deliver the good directly to the customer (either direct or by using a 3rd party delivery carrier).

So How Does Sales and Use Tax Apply to This Transaction?
The answer depends largely on what businesses, customer, and states are involved in the transaction.  Therefore, drop shippers, wholesalers, manufacturers, and retailers must evaluate each transaction and ask themselves the following questions in order to determine whether or not sales tax is owed, and whether a reseller certificate is needed:

  1. Do I Have Sales Tax Obligation?
    - Even when drop shipping is used, the retailer must collect sales tax from the customer if they have nexus in the state where the sale occurs, unless the transaction is exempt.
    - If neither the retailer nor drop shipper has nexus in the state where the sale occurs, the customer is responsible for collecting sales and use tax, unless the transaction is exempt.
    -If the retailer does not have nexus in the state where the sale occurs but the drop shipper does, the drop shipper could be responsible for collecting sales tax depending on the state.
  2. Do States Consider Drop Shipping a Nexus-Creating Activity?
    -In some states, the use of an in-state drop shipper by an out-of-state retailer is considered a nexus-creating relationship.
    -The value of the taxable amount also varies between states.
  3. What Constitutes a Valid Resale Certificate?
    -Most states do not consider the transaction between the retailer and the drop shipper taxable, as long as the retailer provides the proper documentation to the drop shipper.
    -States that are members of the Streamlined Sales and Use Tax Agreement can use the SST certified exemption certificate.
    -Many states also allow out-of-state certificates.
  4. How Can You Get Sales Tax Right?
    -Given the complexity that drop shippers, retailers, wholesalers, and manufacturers face, many require sales tax assistance to get it right.

To learn more about what you can do – as a drop shipper, wholesalers, manufacturer, and retailer – to ensure that you are getting sales tax right, download this free whitepaper: “Sales Tax Implications of Drop shipping” or view a Pre-Recorded Webinar on Sales Tax and Drop Shipping to get answers to your most pressing questions.

by Avalara

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