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Sales Tax and Drop Shipping – Who Pays?


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Ever since people started shipping items across state lines, distributors have been wrestling with a rudimentary question: Who pays the sales tax? This question becomes even more complex when adding a drop ship provider to the equation.  In case you need clarification, a drop shipment is when an item is purchased by a customer then the vendor purchases the item from a third party vendor to deliver that item to the customer.   Drop shipping is a common business practice for distributors and the reasons are numerous.  Many of our Dynamics GP customers are drop shippers for their customers.  By the way Dynamics GP handles drop shipping very, very well!

Let’s take a minute and see about clarifying this complex question: who is responsible for collecting sales tax (if any) and is responsible for reporting the tax to the appropriate state entity.   (Keep in mind that every business should consult with their tax professional and/or CPA.  This article should not be construed as tax advice.)

Complex issues surround defining sales tax such as customer location, vendor location, product sourcing location and drop shipper location. A simplified version of a drop shipment would be:

  • A customer makes an order in a retail environment
  • The order is received and the vendor then places an order with the wholesale supplier or manufacturer who owns the inventory
  • The wholesaler or manufacturer then sends the order to the customer.

DropShip-SalesTax

The problem that drop shipping creates is generally a higher margin of error because of the ever changing tax laws and their complexity. Higher errors then increase the possibility of expensive fines and penalties.

First we need to define Nexus – Tax Nexus

From About.com …“The term nexus is used in tax law to describe a situation in which a business has a "nexus" or presence in a state and is thus subject to state income taxes and to sales taxes for sales within that state. Nexus describes the amount and degree of business activity that must be present before a state can tax an entity's income. If a taxpayer has nexus in a particular state, the taxpayer must pay and collect/remit taxes in that state.

  • If the business has a physical location in the state
  • If there are resident employees working in the state
  • If the business has property (including intangible property) in the state
  • If there are employees who regularly solicit business in the state. "

The questions below will clarify, for now, whether the consumer, wholesaler, manufacturer or retailer pays sales tax and when.

When is there a sales or use tax obligation?

  1. If the retailer has nexus in the state where the sale occurs, then the retailer collects sales tax from the customer - even if the retailer uses a drop ship provider to deliver the item.
  2. If the retailer and drop shipper do NOT have nexus in the state of purchase then they are not required to collect sales tax from the customer; however, the customer is still subject to use tax.
  3. The retailer does not have nexus in the originating state, but the drop ship provider does - then the drop shipper could be responsible for collecting sales tax. Most states currently DO NOT consider a transaction between a retailer and a drop ship provider as a taxable transaction - but some do. You should research this with your state.

Does drop shipping create a nexus in the eyes of some states?

This is a complex question addressing a scenario when a state evaluates a drop shipper in its borders that is being used by an out-of-state retailer to ship its goods. Some states classify the seller of those goods to be responsible for collecting sales tax. Again - this is an area that each state varies; however, in most states remote resellers are not responsible for collecting sales tax.

What is a valid Resale Cert?

Most states do not consider transactions between reseller and drop shipper taxable, as long as proper documentation is delivered to the drop shipper from the reseller. States that are members of the Streamlined Sales and Use Tax Agreement can use the SST certification for this purpose.

This all seems quite complicated right? Over 11,000 different taxing jurisdictions in the United States complicate any efforts to manually control, maintain and implement tax regulations in your distribution process.  Always consult with your tax professional and/or CPA for tax issues specific to your business and industry.  Always look for good sales tax solutions that can be integrated to your ERP and eCommerce software such as Avalara.

Custom Information Services (CIS) employs experts with decades of experience in the implementation of distribution solutions such as Microsoft Dynamics GP, SalesPad and Vicinity Manufacturing software. The most successful distributors take full advantage of the numerous features of these software solutions, and you can expect the same results. Follow this link for a free trial of Microsoft Dynamics GP and experience the difference for yourself.

Find out more about Microsoft Dynamics GP, Managed Services and additional software solutions for Distributors:

Lance Thorley is Marketing Coordinator at CIS, whose primary objective is the Sales and Support of Microsoft Dynamics GP, Managed Network Services and Custom Programming for Microsoft Dynamics GP. CIS is a Certified Dynamics GP Partner and MSP located in North Texas. Contact Lance with any questions or comments at lthorley@customis.com.

by Custom Information Services

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2 Responses to “Sales Tax and Drop Shipping – Who Pays?”

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  2. it’s really good blog article for sales tax updates.