Sales Tax Nexus and Drop Shipments

Sales tax nexus is a common theme in our webinars, Lunch & Learns, and CPE programs.

When discussing sales tax nexus, we often segue into a discussion of drop shipment transactions. Initially, the connection is not clear, but I believe the two are integrally connected.

A typical scenario is when a retailer makes a sale to a customer, and the retailer has a manufacturer or distributor ship product directly to the customer of the retailer. It’s a sale for resale transaction between the retailer and the manufacturer/distributor. As such, the retailer would ideally present a resale exemption certificate to the manufacturer/distributor. Like a lot of sales tax related processes – this is easier said than done. This is where sales tax nexus starts to play a role.

If the retailer doesn’t have sales tax nexus in the state of the customer, then the retailer will not charge sales tax. However, if the manufacturer/distributor has nexus in the state of the retailer’s customer, then the manufacturer/distributor is required to charge sales tax to the retailer. The retailer needs to exempt the sale for resale purposes based on where the product was shipped and tax applied. As an example, let’s say the retailer’s customer is in Georgia and the retailer does not have sales tax nexus in Georgia. In this situation, Georgia is pretty easy to work with and will accept an out of state resale certificate. So the retailer can issue a resale certificate from their home state (where presumably they are registered for sales tax purposes) to the manufacturer/distributor and exempt the transaction from sales tax.

Other states are not as forgiving as Georgia. Let’s say the retailer’s customer is in California. The retailer does not have nexus in California but the manufacturer/distributor does have nexus in California. The manufacturer/distributor will charge California sales tax on the transaction. Unfortunately, California will not accept an out of state resale certificate. The only resale certificate recognized by California is a California resale certificate. And the only way to present a valid California resale certificate is to be registered in California.

This is a critical business process to get right as it could cost a retailer a direct hit to their bottom line in the form of additional sales tax they did not anticipate having to pay – on average around 8%.

For help with identifying the twelve states like California, or other sales tax questions, feel free to reach out to me at TaxConnex.