Sales Tax Collection Obligations Concerning Drop Shipments

A drop shipment is when a vendor accepts an order from a consumer for a product it does not have in stock and directs its supplier (a manufacturer or wholesaler) to ship the product directly to the vendor’s customer. The supplier then delivers the product to the consumer via common carrier or in its own trucks, or may have the consumer pick up the product from the supplier’s location. Thus, there are two sales occurring: first, the supplier (i.e., drop shipper) sells the product to the vendor; and second, the vendor, without taking possession of the product, resells the product to the consumer.

If the vendor has nexus with the destination state, it clearly must collect tax from its customer. Conversely, if neither the vendor nor supplier has nexus with the destination state, neither party must collect tax from the customer. However, states differ on the treatment of drop shipments when only the supplier/drop shipper has nexus with the destination state.

In this problematic situation, some states require the drop shipper to collect and remit tax from the vendor’s customer, even though the drop shipper does not receive payment from the consumer or know the price the consumer has agreed to pay the vendor (i.e., the tax base). Presumably, to lessen the drop shipper’s burden to collect tax from the vendor’s customer, other states refuse to accept the resale exemption for the drop shipper’s sale to the vendor, thereby requiring the drop shipper to collect tax on its sale to the vendor. In such states, the drop shipper may be required to collect tax based on the drop shipper’s price to the vendor, the vendor’s price to the consumer, or a mark-up on the drop shipper’s price to the vendor.

Although perhaps a factor in determining whether a vendor has substantial nexus with a particular state, it is not believed that any taxpayer has been required to collect a particular state’s sales tax solely due to its use of a drop shipper in the state.

If you need help in determining the sales tax consequences of using or being a drop shipper, please contact us.