Everything You Need to Know About Sales Tax for Drop Shipping

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Here at LedgerGurus, we have mostly ecommerce clients, and some of them use drop shippers and some of them are drop shippers themselves. So we see this a lot and we advise them on what to do with sales tax. So I'm really excited to share this knowledge with you today.

And I'm going to use a whiteboard, because for some people it's hard to understand, and it took me a while to understand this as well. So I want to draw it out and make it a very easy, understandable scenario for you, so you understand the sales tax complicates.

1:15 The three parties and two transactions

Okay. So the first question is, let's talk about these three parties that are involved in a drop shipping scenario.

The first one is the customer. So the customer places an order from the seller. The seller doesn't hold inventory, they use a drop shipper. So they in turn order the products from a drop shipper. The drop shipper will actually deliver the product to the customer.

So from customer's perspective, they only deal with the seller. The seller has to deal with both the customer and the drop shipper, because they essentially place an order from the drop shipper. And then the drop shipper delivers the product to the consumer. The customer has no idea about the drop shipper. They simply go to the seller's website, place an order, and then they get a product delivered from another party.

2:11

So let me give you an example. So I shop online a lot and I buy a lot of clothing. One boutique store that I shop with, they are using a drop shipper. So the clothing store I shop with is located in California. So the seller is located in California, and me as the consumer I'm in Utah. I place an order on the seller's website, they send me an invoice, I pay the invoice, and they turn around and place an order with their drop shipper that's actually located in Utah as well. And the drop shipper will send the seller an invoice and have them pay the invoice. And then they deliver the product to me, from Utah to Utah.

So when I get my packages, sometimes I'm wondering, I thought I was shopping with a California company, but how come my package is saying that it's delivered from Linden, Utah, instead of, you know, somewhere in Southern California. And then I realize they're using a drop shipper.

And this happens a lot more than normal customer knows, but drop shipping is very popular and it involves three parties. And the customer deals with the seller, the seller deals with both the drop shipper and the customer, and the drop shipper delivers the product to the customer and sends the seller an invoice.

3:38

Okay, so we got all those three parties straightened out. So there essentially is two transactions, right? So the first transaction, when it comes to sales, is between the customer and the seller. So that's the first transaction. And the second transaction is between the seller and the drop shipper. The seller is essentially buying the product from the drop shipper. And then the delivery happens, which is the third step, is between the drop shipper to the customer.

4:09 Where the seller has nexus

So now let's talk about where these three parties have nexus. So we'll start with the simple one. Customers, they pay sales tax. So we're not worrying about them collecting sales tax. So we're not going to worry about customer's nexus.

We're going to talk about seller's nexus. So if you are an online seller that uses a drop shipper to deliver products to your customers, you will have nexus in, first of all, your home state, where you have physical presence. So this would be where your home state is. And secondly, you need to worry about economic nexus.

So where you have physical presence is going to be your home state and any of your employees, whichever state they reside in. And the second one is economic nexus, and this economic nexus is solely created by your customers. So do not worry about where your drop shippers have nexus. Only worry about where your customers are creating economic nexus for you. Meaning if you have a lot of customers that are placing orders in various states over the economic nexus threshold, like over the 200 transactions or a hundred thousand dollars threshold, then those customers create nexus for you.

5:38

Let's go back to my example. I'm going to write down the example here to mirror what we talked about. Well, just talk about my experience with drop shipping.

So the seller is in California. So obviously she will have physical presence in California. Where she has economic nexus, determined by the customers. So I'm in Utah, but if she doesn't sell enough to Utah that passes the economic nexus threshold for Utah. So Utah is 200 transactions or a hundred thousand dollars value. So if she only sells, let's say she only sells to me, I'm her only Utah customer, then she doesn't have nexus in Utah, because she doesn't pass the economic nexus threshold. Then she shouldn't charge Utah tax. So she shouldn't charge me tax when I place this order, because the seller does not have nexus in this state.

6:44 Where the drop shipper has nexus

So then let's talk about the second transaction, between the drop shipper and the seller. In this scenario, it's almost like the drop shipper is the seller to the seller, because the seller will send the order to the drop shipper and the drop shipper will send the seller invoice. So when the drop shipper is sending the invoice to the seller, they will charge sales tax where they have nexus.

So where does the drop shipper have nexus? First of all, the drop shipper will have nexus where they have physical presence. So wherever their warehouse is located. If they use a company owned vehicle instead of a common carrier to deliver products, that will incur physical presence as well. So they have nexus where they have physical presence.

7:38

First and second, they have nexus in where they have economic nexus. And this is a big issue, because drop shippers, like in principle, they deliver so many products to all kinds of business owners. One drop shipper can have multiple sellers. And if they aggregate their sales to all the sellers and allocate it based on where the customers are, where they're delivering to, they might have economic nexus in so many different states.

And this is why most of the time drop shippers will charge sellers sales tax on this invoice, because the drop shipper either have physical presence or have economic nexus in where they're delivering to. And because so many drop shippers deliver to all over the country for so many sellers, on the aggregate level the drop shipper have passed economic nexus in those states.

8:45

Let me know if that's confusing and I'm happy to explain more in the comments. But what we see most of the time is sellers only have physical presence in their home state, have economic nexus when they sell a lot into other states. Drop shipper, they have physical presence either through where they have stores, warehouses, employees, or through their delivery. If they use a company owned delivery vehicle into other states, that's considered physical presence. Or if they deliver a lot of products for different sellers, and then on an aggregate level they pass economic nexus threshold, and they will have to charge tax on their invoice to the seller.

Okay, let me know if you have questions. I know this is not the easiest concept to grasp, and it really took me a while to understand all of it too.

9:54 Who charges sales tax to whom

So after we understand these different things that would trigger nexus for the seller and for the drop shipper, let's talk about sales tax.

So when the seller sends an invoice to the customer, it needs to include sales tax to the customer where they have physical nexus, and if they pass economic nexus in that state where the customer is residing. If it doesn't have physical presence in where the customer is, or it doesn't pass economic nexus threshold in where the customer is, it doesn't need to charge sales tax.

But this is the important part, and we get most questions asked by our clients that are either the seller or drop shipper, to ask, why do they need to charge sales tax? Who should be paying sales tax?

10:41

So it's very important to know that the drop shipper charges sales tax to the seller. It's the drop shipper's responsibility to either charge sales tax from the seller where they have physical presence or where they pass economic nexus presence, if the seller is in one of those states, unless the seller can give them resale certificates.

So this is the interesting part. So the drop shipper will charge the seller sales tax unless the seller can provide the drop shipper a valid resale certificate. So if you are a seller and you use a drop shipper, you are most likely being charged sales tax, unless you can provide a resale certificate to your drop shipper, telling them I'm buying these products for resale and the customers will eventually pay sales tax, so don't charge me sales tax on my invoice.

If you are a drop shipper, after you analyze your nexus footprint and you determine where you have nexus, charge sales tax in those states where your sellers are, unless they can provide you a resale certificate.

12:03 Getting a resale certificate across state lines

So if you are a seller and you want to provide a resale certificate to your drop shipper, so you don't have to pay sales tax on the invoice that your drop shipper is sending you, there's lots of ways to get a resale certificate.

Obviously, if everybody is in the same state, the one form would be sufficient to provide to your drop shipper. If the seller and the drop shipper are in the same state, that makes it easier too. But sometimes where the seller have nexus, where they're located, and where the drop shipper is, is not the same.

12:40

So let's go back to my example. If the seller's in California, the drop shipper's in Utah, and the seller does not have physical presence or economic nexus in Utah because they don't sell enough, and they are not located in Utah, they don't have any employees, they are not going to register to collect tax in Utah. So they don't have a Utah resale certificate.

But here the warehouse, the drop shipper in Utah, they drop ship it for so many business across the country, and especially in California, just as an example. So they pass economic nexus and they're delivering to Utah customers. So they will charge sales tax to this California vendor.

So the California vendor wants to not pay sales tax, because it's saying I'm reselling the products to other customers. But the California seller does not have a Utah resale certificate. It only has a California resale certificate, but the Utah drop shipper won't accept an out of state resale certificate. They will only accept Utah.

14:02

And actually, something else which I talked about in the SST and MTC forms, that's why it's so good to utilize the MTC and the SST form, because those forms are accepted by so many states.

So if the seller does not have nexus where the drop shipper has, and the drop shipper is asking for resale certificate, and the seller does not want to register in all the states that they don't have economic nexus or physical presence in, the seller right here, to get this resale certificate, they can use the MTC or the SST form.

Or there is 10 states that are very difficult and you have to register to get the resale certificate to provide to your supplier. But besides those 10 states, most of the time the seller can either use the MTC form or the SST form to provide resale certificate to their drop shipper, so the drop shipper won't charge them sales tax on their transaction.

15:14 How to map your own scenario

Okay, that is a ton of information. And I'm sure you guys have like different scenarios where your business is operated in. So feel free to leave me comments and ask me questions.

But just chart it out for your scenario and ask yourself, if you are the seller, ask yourself, where do I have physical presence? Where do I have economic nexus? And know that your economic nexus is solely determined by your customers, by your sales.

And if you are a drop shipper, ask yourself where you have physical presence, where you have the economic nexus. And that's determined by where your delivery, where you have people, where you have warehouse, and for all the sellers you're delivering for, they are creating economic nexus for you.

So let me know if you have any questions. And if you like this video, please like it and share it with your fellow drop shippers and sellers that use drop shipping, so we can just share the knowledge and have them understand where sales tax come in as well.

If you want to know more about sales tax, we do have an intro master class that you can register for. It has a ton of good information. And if you are an accountant or a bookkeeper and you want to come and work with me, check out our HR page, we are actively hiring. So hopefully you can join the team.

And I hope y'all have a good day and I'll see you soon. Bye.