Dropshipping has become increasingly popular as more and more people turn to the internet to do their shopping. Rather than purchasing an ample product supply from a wholesaler, storing the inventory, and shipping when a customer makes a purchase, dropshipping allows a retailer to buy products only after the wholesaler receives payment and makes the shipment to the customer. It’s a relatively simple way of starting your own eCommerce store until it comes to sales tax. Because each state has different tax laws, it can be a little challenging. Luckily, we will cover all of the dropshipping sales tax basics you need to know.
What is Sales Tax?
Because most products are taxable, you will likely need to account for sales tax (also referred to as sales and use tax in some states). Sales tax is essentially a tax you pay to the government when you sell goods and services. If you plan to sell taxable products, you will need to collect sales tax from your buyers.
For small local businesses, sales tax is often pretty simple as they just need to know the sales tax from which their company operates. However, if you operate in several states (as you do online), you will pay a different tax rate from state to state.
When it comes to dropshipping, you may wonder who collects the sales tax, the seller or the supplier?
How Dropshipping Sales Tax Works
When dropshipping, there are three parties involved. The supplier supplies you, the seller, with products that then sell the products to the customer. If you, your supplier, and the customer are located in different states, then you will likely all have different state tax rules.
There are many variables that come into play when determining who will collect the sales tax. We will go over different scenarios to give you a better understanding of dropshipping sales tax.
How To Handle Sales Tax Issues On Your Own
First things first, make your business official by consulting with a professional to determine which licenses and certificates you may need in the state you will be selling from. More than likely, you will need a sales tax permit (also referred to as a seller’s permit). Because you will probably perform your dropshipping business at home, you’d rarely require a local business license. However, it never hurts to double-check your local laws and regulations.
With drop shipping transactions, the point of sale, or where the transaction takes place, is essentially the buyer’s delivery address. Because of this, since you are the “middleman” of this transaction, you may be the one responsible for sales paying sales tax depending on where you and the supplier are located.
More often than not, you are not required to pay sales tax on products purchased from your vendor. You are the retailer would not pay sales tax from the vendor, but collect the sales tax on the sale of the item to the end user. To not pay sales tax on merchandise that is being resold, the vendor will request a resale certificate (also referred to as a resale exemption certificate) will allow you to be exempt from paying sales tax for purchases you intend to resell.
The best method to collect sales tax would be to use an eCommerce platform, such as Shopify, which basically handles sales tax for you.
Understanding State Laws
Businesses have a legal obligation to pay income tax to the federal government, but there is no federal sales tax in the US. Each state has its own tax percentages and laws.
Some states that do not have a state sales tax will allow locations within the state to charge local sales tax. So, it is important to always double-check the sales tax for the specific state and city where the item is shipped to.
Adding to the complexity of sales tax laws, each state has different thresholds for reporting and paying sales tax. Many states chose to not burden smaller businesses and only require sales tax obligations if the remote seller ships over 200 transactions or over $100,000 in sales to the residents in their states. Other states require paying sales tax if only one transaction is made in their state.
As previously mentioned, there are two transactions within three parties involved in dropshipping. In addition to collecting sales tax, you yourself may be required to pay sales tax depending on where your seller is located.
Your supplier may be registered in one of the 45 states with sales tax. To determine the state’s tax rate, you will look at the “ship to” state.
If your supplier registered to collect sales tax in that state, they will be required to collect on all transactions in that state. The only exception is if they accept a resale certificate instead of collecting tax.
Simply put, the supplier will either collect the state tax for which they are registered or provide a resale certificate for that sale.
The vendor may be registered in many states (45) with sales tax plus the District of Columbia (D.C.).
TaxJar is a great resource for keeping up with sales tax requirements.
What is Nexus?
Nexus (or economic nexus) is the relation between a state that requires sellers to register and remit sales tax within that state. Although Nexus typically only applies to businesses that have a physical presence, such as having an office, warehouse, fulfillment center, or employees outside of the state where you are “headquartered.”
The U.S. Supreme Court determined in the case of South Dakota v. Wayfair, that an out-of-state seller could establish nexus through economic activity alone and that physical presence is not required to create nexus.
Nexus used to make sales tax even more challenging for small business owners with a dropshipping business. Luckily, there have been some changes made for remote sellers. You more than likely will not run into any issues, but it is helpful to know and worth looking into to ensure you’re managing sales tax properly.
As a drop shipper, the main issue you will run into is if your supplier has sales tax nexus. Because the supplier is billing you, even though the products will be shipped to the customer, they will be required to charge you sales tax. If you have a resale certificate, then you will be considered tax-exempt, however, you will need to collect sales tax from your customer.
So, the best way to avoid paying any sales tax is to ensure you have the proper resale certificate documentation. This document is valid in any state that has sales tax nexus.
7 Dropshipping Tax Questions Answered
Here are the most commonly asked questions regarding drop shipping sales tax.
How Do I Pay Tax on Dropshipping?
As with any job, you are legally obligated to pay income tax on any profits you make in your business. You will pay this tax to your government in the state you live in and may pay annually or quarterly. Online sellers, such as dropshippers, will need to register with that state’s Department of Revenue or Department of Taxation and collect and pay sales tax.
How Much Sales Tax Do You Pay For Dropshipping?
Typically, you will not have to pay sales tax out of pocket. Instead, you will charge sales tax based on the resident’s location. You usually will not have to pay any sales tax to manufacturers but will require a resale certificate.
Can I Avoid Paying Sales Tax For Dropshipping?
You can avoid paying sales tax when dropshipping by having a resale certificate. This certificate will allow you to purchase products with the intent to resell them without paying sales tax on those items. You will present your resale certificate to your supplier, so they know they do not need to collect sales tax from you. However, the supplier has the right to refuse a resale certificate. Usually, a supplier would reject a resell certificate because they do not want their products resold.
Do You Need a Sellers Permit For Dropshipping?
You will need to check with your state’s Department of Revenue to determine exactly which permits you will need to start a dropshipping business. Most suppliers will require all of their resellers to have a seller’s permit before they can purchase products. In order to collect sales tax from customers, you will need a seller’s permit and then will need to report the sales tax collected on a regular basis.
Should I Charge Sales Tax From Customers?
In the United States, all sellers are required to collect sales tax if you live in a sales tax nexus state. In most cases, you will need to register for sales in that state. However, each state’s laws vary so you will need to look into your state’s laws.
Does Shopify Collect Sales Tax?
If you sell your dropshipping products on Shopify, you have the option to have Shopify collect sales tax. Shopify will automatically collect the correct sales tax on every order. This can be extremely beneficial to ensure that you don’t accidentally charge the wrong sales tax. Each customer will more than likely live in different states, so sales tax will vary.
Do You Need a Sales Tax ID to Dropship?
In order to legally make a sale of tangible personal property in a state that taxes goods, a sales tax permit or sales tax ID will be needed.
Note that this is different from an Employer Identification Number (EIN), which is number from the Internal Revenue Service that uniquely identifies a business for tax purposes. Businesses that are registered as a sole proprietorship aren’t required to get one unless they have employees, but LLCs, corporations, and partnerships will need to get them, regardless of whether they have employees..
Dropshipping is a business that has three parties: the supplier, the seller (you), and the customer. You usually will not be required to pay sales tax to the supplier but will need to collect sales tax from your customers. Each state has different sales tax laws and required permits, so be sure to look at your state’s regulations. Certain e-commerce platforms, such as Shopify, will automatically collect sales tax for you.
Please be sure to consult with an accountant to be sure the dropshipper has the correct permits and is collecting sales tax as required, otherwise, the business may be on the hook to repay the sales taxes due.