Drop Shipping and Texas Sales Tax Nexus: Who Does the Comptroller Target?

Drop shipping has become increasingly popular in recent years, with several online platforms enabling retailers to make sales without maintaining their own inventory. But while drop shipping may offer a simplified business model for retailers, strict tax rules apply, and retailers must ensure compliance with all applicable state and federal requirements.

For retailers that have products drop shipped to customers in Texas, this includes complying with the state’s sales tax requirements. The Texas Comptroller actively enforces compliance among remote sellers—though there is a key exception for those that have no physical presence in the state. For those who are subject to Texas state sales tax compliance, failing to comply can lead to audits, civil liability, and even criminal exposure in some cases.

Retailers Are Responsible for Collecting and Remitting Sales Tax in Texas

In Texas, the law is clear: Retailers are responsible for collecting and remitting sales tax. Even though manufacturers or fulfillment centers may ultimately be responsible for delivering products to in-state customers, the law is clear that the retailer’s sale to the in-state customer is the event that triggers potential sales tax liability.

Due, at least in part, to the fact that Texas does not have an individual income tax, the Texas Comptroller prioritizes sales tax enforcement more heavily than its counterparts in many other states. This includes prioritizing sales tax enforcement among remote sellers. When remote sellers are required to collect and remit Texas sales tax, facing an audit is a very real possibility, and Texas Comptroller audits can lead to liability for substantial back taxes, interest, and penalties.

As noted above, criminal exposure is also a possibility in some cases. Specifically, Texas law provides that intentionally or knowingly failing to pay tax due can be prosecuted as either a misdemeanor or a felony, depending on the amount of unpaid tax involved. In cases involving $200,000 or more in unpaid sales tax, intentional and knowing violations can be prosecuted as first-degree felonies.

Economic Nexus: When Out-of-State Retailers Are Required to Collect and Remit Texas Sales Tax

All of this is subject to one major caveat: Out-of-state retailers are only required to collect and remit Texas state sales tax if they have “nexus” with the state. So, what is nexus?

There are two ways that an out-of-state retailer can establish nexus for purposes of triggering Texas state sales tax compliance obligations: physical nexus and economic nexus. As its name suggests, physical nexus requires an in-state presence—although this presence can be both minor and temporary.

As a result, economic nexus is the primary concern for most out-of-state retailers that work with drop shipping companies. While Texas law generally requires remote sellers to collect and remit sales tax, the law provides an exception based on in-state revenue:

“The comptroller will not enforce the [sales tax] permit requirement . . . or the collection obligation . . . on a remote seller whose total Texas revenue in the preceding twelve calendar months is less than $500,000.”

“Total Texas revenue” is defined as, “the gross revenue from the sale of tangible personal property and services for storage, use, or other consumption in this state recognized under the accounting method used by the seller, and includes separately stated handling, transportation, installation, and other similar fees collected by the seller in connection with the sale.” It covers “the aggregate sum of all sales made on all mediums,” including retailers’ websites, social media platforms and online marketplaces.

As a result, if a drop-ship retailer makes less than $500,000 in sales to customers in Texas each year, the retailer does not have economic nexus with the state and is not required to collect and remit sales tax. However, once a drop-ship retailer exceeds $500,000, it must begin collecting and remitting sales tax the following year and continue to do so unless it formally cancels its permit with the Texas Comptroller. If a retailer’s total Texas revenue falls below $500,000, that alone is not sufficient to allow the retailer to stop collecting and remitting sales tax in Texas.

It is worth emphasizing that while economic nexus is the primary concern for remote sellers, they must also be careful to avoid establishing physical nexus. Unlike the economic nexus, there is no in-state revenue threshold for physical nexus. As we mentioned above, even minor and temporary contacts can be sufficient to establish physical nexus, including having a phone number that is answered in the state.

Are Manufacturers and Fulfillment Providers Ever Required to Collect and Remit Sales Tax in Texas?

As a general rule, manufacturers and fulfillment providers that engage in wholesale transactions with retailers are not required to collect and remit sales tax in Texas. However, this assumes they are not engaged in any other commercial activities that trigger state sales tax compliance.

If a manufacturer or fulfillment provider also makes retail sales to customers in Texas, for example, then it will need to collect and remit sales tax if it has either physical nexus or economic nexus with the state. Additionally, if a manufacturer or fulfillment provider also acts as an online marketplace, it may have Texas sales tax compliance obligations in this case.

Texas’s sales tax rules differ from the rules in many other states. As a result, remote sellers and other businesses that are compliant in other states should not assume that they simply have the same obligations in Texas. To mitigate their risk of civil or criminal liability, all businesses that sell to customers in Texas should take an informed, proactive approach to Texas state sales tax compliance.

Request a Call with an Experienced Texas Sales Tax Lawyer at Brown PC

If you need more information about the risks of noncompliance with Texas’s sales tax laws, we invite you to get in touch. To request a call with an experienced Texas sales tax lawyer at Brown PC, please call 888-870-0025 or contact us confidentially online today.