Drop shipping has become a hot trend in ecommerce, allowing sellers to run their businesses without stocking inventory. While this model reduces upfront costs and lets you focus on sales and customer service, it also comes with its own challenges—especially around sales taxes.
Are you wondering how sales tax works in the world of drop shipping? This ultimate guide is here to help. We’ll break down the basics and give you the tools to handle your sales tax responsibilities like a pro.
What is Drop Shipping?
Drop shipping is an ecommerce model where an online store sells products to consumers without keeping them in stock. Instead, when a store sells a product, it purchases the item from a third-party vendor, who then ships it directly to the customer. In essence, the seller never sees or handles the product. Imagine this: You’re the retailer, but instead of having a warehouse stacked with products, your role is more of an intermediary. When a customer orders on your website, you forward the details to a third-party supplier, who then handles packing and shipping the product directly to the customer’s doorstep. Pretty neat, huh? This fantastic setup means you don’t have to deal with the nitty-gritty of inventory management or shipping logistics. It’s like being a curator for an art gallery; you select what goes on display and how to present it, while someone else handles the behind-the-scenes details.The New Standard: Economic Nexus
While physical presence used to be the only way to trigger tax obligations, the 2018 Supreme Court changed everything. Today, most dropshippers trigger economic nexus once they cross a state’s financial threshold, most commonly:- $100,000 in gross sales, or
- 200 separate transactions in a calendar year
The Three Points of View of Drop Shipping
The Customer
From the customer’s viewpoint, it’s business as usual—just like any other online shopping experience. They scroll through the online catalog, pick out what they like, and pay the retailer, including any relevant taxes. Then they simply wait for their package to arrive, hopefully within the estimated delivery window.The Seller
When an order and payment come in from a customer, the seller springs into action. For any products not sitting in a warehouse—because we’re talking drop shipping here—the seller quickly places an order with their trusty supplier. Along with the payment, the seller shares the customer’s shipping details with the supplier to ensure the package reaches the correct destination.The Supplier
Once the supplier receives the order and payment from the seller, it’s their turn to act. They locate the ordered items within their inventory, neatly package them, and then ship them to the customer’s doorstep. It’s a streamlined process that cuts out the middleman for shipping, making the whole transaction as efficient as possible.Who Should Pay Sales Taxes in Drop Shipping?
Determining who is responsible for collecting and remitting sales tax in a drop-ship scenario can be complex. Sales tax is regulated at the state level, and each state has its own rules. Generally, the seller (the retailer) should collect sales tax from the customer and then remit it to the appropriate tax jurisdiction. However, in drop shipping, since the product goes directly from the supplier to the customer, three potential parties are involved: the customer, the seller, and the supplier.- If the seller (retailer) has a business presence (sales tax nexus) in the same state as the customer, then the seller is responsible for collecting and remitting sales tax.
- If the seller (retailer) doesn’t have nexus in the customer’s state, but the supplier does, the supplier may be required to collect and remit sales tax in the customer’s state (this is particularly common in California; see the ‘10% Markup’ section below).
- If neither the seller (retailer) nor the supplier has nexus in the customer’s state, generally, no sales tax needs to be collected and remitted.
Marketplace Facilitator Laws: Is the Tax Already Paid?
If you drop ship through platforms like Amazon, eBay, Etsy, or Walmart Marketplace, your tax burden is significantly lower. Under Marketplace Facilitator Laws active in 45+ states, the platform is responsible for calculating, collecting, and remitting sales tax on your behalf. Note: You may still be required to register for a sales tax permit in states where you have nexus, even if the marketplace handles the money, to report your “exempt” marketplace sales.Sales Tax Exemption Certificates in Drop Shipping
Sales tax exemption certificates can make the already complex world of drop shipping even trickier. Here’s the deal: when a retailer buys items for resale, they can often avoid paying sales tax by providing a resale certificate to their supplier. It’s important for both parties, the retailer and the supplier, to be well-versed in the rules governing these certificates in the states where they operate.- Tennessee accepts out-of-state certificates for standard resale. However, they are notoriously strict about dropshipping. If a supplier ships to a TN customer on behalf of an unregistered retailer, the supplier often must charge tax.
- Maryland has recently updated its guidance to allow more flexibility for registered out-of-state retailers, provided the goods are strictly for resale.
- Some states, such as Hawaii, Illinois, and Massachusetts, do not accept out-of-state resale certificates for drop shipments. If your customer is in one of these states and you aren’t registered there, your supplier may be forced to charge you sales tax.
Dropshipping in California: The 10% Markup Rule
California is the most complex state for dropshippers. If your supplier is in California (or has a warehouse there) and ships to a CA customer on your behalf, and you are not registered for a CA permit, the supplier is liable for the tax. To protect themselves, the California Department of Tax and Fee Administration (CDTFA) requires the supplier to tax the actual retail price if known. The 10% markup is a default safety net when the retailer refuses to share their margins.Preparing for Sales Tax Compliance
Here are some steps to help you prepare for sales tax compliance:- Identify Nexus: First, determine where you must pay sales tax and which states your business has a presence in. This might include states where you have physical locations, employees, or even a high sales volume.
- Register for Sales Tax Permits: Before collecting sales tax, you’ll need a permit from each state where you have nexus.
- Calculate and Collect Sales Tax: Use automated tools or consult with tax professionals to ensure you charge the correct rate.
- File and Remit Sales Tax: Depending on your sales volume, you’ll need to file and remit sales tax on a monthly, quarterly, semi-annually, or annual basis.
- Document Exemption Certificates: If you’re using resale certificates, keep accurate records showing compliance with the law.
Frequently Asked Questions
1. What permits do you need for dropshipping?+
For dropshipping, you’ll generally need the same permits and registrations required for most businesses. This typically includes obtaining a business license or local permit, depending on your city or state requirements. You’ll also need to register your business with the appropriate state or local agencies.
In addition, most dropshippers must apply for a federal tax ID number (EIN), register with their state’s tax authority, secure a sales tax permit to collect and remit sales tax where required, and comply with state rules on unemployment insurance and workers’ compensation if they have employees.
2. Do I need to pay taxes if I sell on Spotify?+
Yes. If you sell on Shopify, you’re generally responsible for handling your own tax compliance. As the merchant of record, you must register for the required sales tax permits, file returns, and remit any sales tax you collect to the appropriate state authorities.
Shopify Tax now offers an automated filing feature in eligible U.S. states. However, you’re still responsible for ensuring your registrations and overall compliance are properly set up.
Learn more about Shopify Tax with our free guide: Does Shopify Collect Sales Tax? A Complete Guide To Compliance
3. What is the easiest item to dropship?+
There are 150 best dropshipping products to sell right now.
Here are some of the most searched product categories for dropshipping:
- Apparel and footwear
- Beauty and personal care
- Kitchen and dining
- Baby products
- Pet supplies
- Home décor
- Phone accessories
- Office products
- Tools and home improvement
- Car accessories