To help you understand some of the main issues related to drop shipments, we’ve assembled some fundamentals and FAQs.
Drop shipments are common but tricky transactions. Given that a large number of companies are dealing with these transactions in a changing sales tax landscape, there are some common misunderstandings floating around.
How can you tell drop shipment facts from fiction? Well, it can certainly take a lot of painstaking research – especially since rules vary state to state. We break down four drop shipment myths to set the records straight in the Post-Wayfair sales tax environment to save you some of the headache.
Note: We will use the term shipper for the manufacturer/wholesaler/supplier (the entity that ships the goods directly to the customer) and seller for the retailer/distributor (the entity that sells the goods to the customer) to explain drop shipment scenarios.
Drop shipment laws did not change after Wayfair. Many companies are registered in more states as a result of the Wayfair decision and may be unfamiliar with the drop shipment rules in those states.
As sellers and shippers register in more states, they are requiring certificates from their customers in more states. A specific point of confusion due to sellers/shippers’ general unfamiliarity with new states’ drop shipment rules is they claim to require certificates from the actual ship to state. Which leads us to our second myth…
Incorrect! Shippers can still accept home state certificates from sellers for 30+ states after Wayfair. This misconception stems from growing registration requirements of sellers and potential overstepping of shippers making assumptions about sellers’ nexus obligations.
The shipper does not have a responsibility to ascertain whether the seller has nexus in the ship-to state and therefore should be registered and have a state-specific sales tax number. Even though the shipper is the one to accept a home state certificate from the seller, it is not the shipper’s obligation to monitor or dictate whether that seller must register in a state.
Let’s walk through a drop ship example.
Kansas is a Streamlined Sales Tax state, meaning the seller can use the SST exemption certificate and put use their home California sales tax number on the Kansas line of the form. The shipper can still accept the SST certificate even though the seller doesn’t have a Kansas-specific number on the Kansas line – the seller’s home state number suffices.
Because Kansas does not have certain thresholds to create economic nexus, it is very easy for the shipper to assume the seller has economic nexus with the state and should be registered and have a Kansas-specific number. However, this is not the shipper’s responsibility to determine.
Drop shipping can, in fact, create nexus. Post-Wayfair, if sellers or shippers exceed economic nexus thresholds into a ship-to state, they have nexus and must register with that state. Sellers and shippers must have a mechanism in place to monitor their sales in all their ship-to states.
An often overlooked way drop shipments can create nexus for a seller is through seller-owned inventory in a third-party warehouse. If a seller uses a fulfillment house to store inventory that is owned by the seller, nexus is created in the state where the warehouse is located through physical presence. The seller has nexus without examining economic nexus thresholds.
Other activities to watch for that can create nexus in certain states are packing and shipping orders, accepting and processing returns, and accepting phone and mail orders.
Depending on the state, the shipping method can impact the type of exemption certificates sellers can issue.
A great example is the state of Florida. Florida’s drop shipment rules state that if the good is shipped from outside the state via common carrier, the seller can provide a home state number on the SST certificate. However, if the good is shipped from a location inside the state of Florida, the seller must be registered in Florida to collect tax and provide the Florida certificate.
In Connecticut, a shipper is not required to collect tax and elicit a certificate from the seller if the shipper uses an out-of-state common carrier to deliver goods to the customer. In Kansas, if the shipper delivers a good in its own truck or the customer picks up the product, the transaction is not considered a drop shipment.
Things are bound to get a little confusing when three parties are involved in a single transaction involving multiple layers of documentation. The Wayfair decision has instigated even more confusion as more companies try to get caught up with the sales tax obligations, including those caused by drop shipment transactions.