The Hidden Sales Tax Burden of Drop Shipping

The Hidden Sales Tax Burden of Drop Shipping

March 31, 2023

What You Need to Know About Your Sales Tax Obligations with Drop Shipping

Rarely do opportunities look as sweet as the drop shipping business model. It is packed with benefits for all parties—the seller, the customer, and the drop shipper…so there must be a catch. And in fact, there is. Having three parties involved in the transaction adds another dimension when it comes to sales tax obligations.

What Is Drop Shipping?

Drop shipping happens when a manufacturer/wholesaler sends their product directly to a consumer after an order is received and paid to a retailer. The order and payment from the retailer to drop shipper provides the customer’s shipping address. The customer receives the product they want, the retailer carries no inventory—nor its costs, warehousing or other expenses—and the drop shipper makes the sale without the use of their own marketing dollars or having to bear the cost of having inventory across the country in situations where they typically own the goods until they are sold.

A Multitude of Sales and Use Taxes

Sales and use taxes—the taxes on goods purchased—are assessed by individual states, as well as local cities, districts, counties, and parishes. Each of these governing bodies can have their own tax rates, tax exempt categories, due dates, filing and payment requirements, and fines. States can also issue sellers permits or licenses, resale certificates, and exemption certificates. Businesses that sell goods in each state are encumbered with needing to know and follow each state’s rules and regulations.

Drop Shipment Sales Tax Obligations and Nexus

For every sale of a taxable product in a state or to a state resident, states expect one of the parties to collect and remit sales tax funds to them. With three or more parties involved in a drop shipping event, it’s easy for the process to become very complicated, very quickly.


In drop shipping, the 3 parties—the seller, the customer, and the drop shipper—may all be in one state or be located in two or three different states. While a few states don’t assess sales tax—Alaska, Montana, New Hampshire, and Oregon—the rest of them do, and will require sales tax payments. The two businesses involved in drop shipping need to be aware of their nexus status in each state.

Nexus is when there is a relationship or business presence within a state.

Physical nexus—having a brick and mortar store, warehouse, or employees or affiliates—used to be the sole guideline for nexus before the landmark Supreme Court ruling of South Dakota v. Wayfair in 2018 that confirmed that states had the right to tax transactions based on economic nexus—businesses exceeding a specific revenue or transaction volume as defined by each state.


Sales tax is often seen as a destination tax, meaning that the state that is able to receive the sales tax funds is the customer’s state where the product is being shipped.

Drop Shipment Transactions – How They Work

A typical drop shipping scenario involves three parties and three transactions.

  1. The customer orders a product from an online store, such as a treadmill.
  2. The online store (a retailer) receives the order and sends their order and payment for the treadmill to the drop shipper (the manufacturer or wholesaler).
  3. The drop shipper then completes a tangible goods transaction by sending the treadmill directly to the customer.

With sales tax, the primary obligation for collecting and remitting the tax is first with the party that has nexus within the state. The drop shipper will automatically have nexus by physically shipping their goods into the state. The retailer may or may not have physical or economic nexus in the customer’s state.

Responsibilities of Drop Shipments

Since the drop shipper has physical nexus, they are obligated to have a seller’s certificate within the customer’s state and need to ensure that they assess tax on the retailer’s purchase unless the retailer has a valid resellers certificate on file for that state. The amount due to the state may be a percentage of the cost to the retailer, the cost to the retailer plus an additional percentage, or may be on the retail price the product is sold, if it is known.


When the retailer has nexus in the state and a seller’s permit there, they would be obligated to charge and collect tax from the customer. They’re also responsible for filing sales tax returns with the state and remitting the tax to them on a timely basis. The retailer should supply the drop shipper with the valid reseller certificate that relieves the drop shipper of their tax obligation on the sale and their wholesale invoice to the retailer would not include tax. If the retailer has not supplied the wholesaler with the certificate, they would be charged tax, increasing their cost of goods.

Easing the Tax Burden of Drop Shipping

Many states participate in one of two groups that help to simplify the resale certificate process, the Multistate Tax Commission and the Streamlined Sales Tax Governing Board. Each provide forms and processes for you to use your home state resale certificate with their state members. Some states require that you also obtain resale certificates in their states and other states don’t participate in either group.


Resale activity that is conducted in marketplaces such as on Walmart.com, Amazon, Etsy, or eBay are subject to marketplace sales tax regulations that require them to facilitate the sales tax transactions and remit the funds to the states. While this simplifies the burden on the sellers who work on those platforms, they are still obligated to properly set up and maintain their account records. Similarly, Shopify and other website seller platform contain options for calculating taxes with multiple steps that must be followed.


Specialized, automated sales tax solutions are also available through online tax processing companies. They offer options to receive your transaction records, calculate sales tax, and even file returns on your behalf. While this option may be costly for smaller businesses, it can be a good solution for those who have grown to a significant size.

We Welcome Your Tax Questions

If you are a drop shipper or retailer who uses drop shipping as your business model, the Sales and Use Tax professionals at REDW can work with you to refine your tax processes and ensure you’re meeting all your state and local tax obligations. We look forward to hearing from you. Contact us today.

More Insights From REDW State and Local Tax Advisors

Recent Posts