You buy products from a supplier, but leave them in the supplier’s warehouse. As orders come in, the supplier ships the products directly to your customers.
You run the business from Michigan. You have no employees in the warehouse’s state, and you may never have visited it.
But you own merchandise sitting there.
That fact can create tax obligations outside your home state. The warehouse does not have to belong to you for the inventory inside it to matter.
Who Owns the Products?
There is an important difference between buying products as customers order them and purchasing inventory that a supplier holds for you.
In a typical drop-shipping arrangement, the supplier owns the stock until a customer order triggers your purchase. In the arrangement we are discussing here, you have already purchased and taken ownership of finished products. The supplier is storing your merchandise and shipping it as needed.
Both arrangements may look the same to your customer. They can produce different tax consequences for your business.
Before deciding which rules apply, look at the purchase agreement. Paying a supplier does not always mean ownership has transferred. A deposit toward a future production run may still be a supplier deposit.
For this article, we are assuming you own the products and they are stored at a supplier’s warehouse in the United States.
Your Inventory Can Give Your Business a Physical Presence
The formal term for a connection that allows a state to impose certain tax obligations is nexus.
An office or employee can establish that connection. Inventory can, too.
Leaving your products in someone else’s building does not necessarily keep your business from having a physical presence in that state. Pennsylvania, for example, expressly identifies inventory stored at a distribution or fulfillment center as a potential source of income and sales tax obligations for online retailers.
The details and exceptions vary by state. But “we don’t own the warehouse” is not enough to conclude that there is nothing to review.
Small Sales Do Not Automatically Put You Below the Limit
Many ecommerce sellers have heard about state sales tax thresholds. They assume that if their sales into a state are below its threshold, they do not need to collect tax.
That can overlook an important distinction.
Economic nexus thresholds generally address sellers without a physical presence. Owning inventory in the state can create a separate reason to register and collect tax. You need to evaluate the inventory presence before relying on a remote-seller sales threshold.
Also, where your products are stored and where your customers receive them are two different questions.
Inventory in one state does not mean every shipment from that warehouse is taxed by that state. You still need to determine the applicable treatment based on the transaction and its destination.
Sales Tax Is Only Part of the Review
The next question is whether owning that inventory creates state income tax or other business tax obligations.
Do not assume this was resolved because someone set up sales tax collection.
A state may consider inventory ownership when determining whether your business is subject to its income or franchise tax rules. The result depends on the state, your business structure, and the activities involved.
Some sellers have heard that Public Law 86-272 protects businesses selling physical products across state lines. That protection is limited. It generally concerns solicitation of orders approved outside the state and filled by shipment from outside the state.
Owning stock maintained for fulfillment in a state can put the business outside those protected activities. You should not assume the protection applies without reviewing the arrangement.
Marketplace Sales Tax Collection Does Not Settle Everything
If you sell through a marketplace, it may collect and remit sales tax on the transactions it facilitates.
That is useful. It does not tell you whether you have an income tax filing obligation.
It also does not resolve how to handle sales made through your own website or another channel. Depending on the state, registration or reporting requirements may remain even when a marketplace handles tax on its sales.
Review each tax and each sales channel separately. “The marketplace handles it” is too broad an answer.
Know Where Your Supplier Keeps Your Products
You should be able to identify where your inventory is physically located.
That means more than knowing the supplier’s billing address. A supplier may operate several warehouses or move products between facilities.
Ask for records showing:
- The warehouse addresses where your products are held.
- When your inventory first arrived at each location.
- The quantities and costs assigned to your business.
- Transfers between facilities.
- Who owns the products at each stage under the agreement.
Those records support both the tax review and the inventory balance in your books.
If you own merchandise held by a supplier, your accounting records should account for it even though it is not sitting in your own building. Reconcile the supplier’s reports with purchases, shipments, and the balance in your accounting system.
Review the Arrangement Before Inventory Starts Accumulating
Having inventory in another state does not necessarily mean a large tax bill. It does mean there is a question to answer.
Before committing to a supplier-held inventory arrangement, find out where the products will be stored, when ownership transfers, and what registrations or returns may be required.
If the arrangement is already in place, start with those same facts, including when it began. Then determine whether prior periods need attention.
Your business address tells you where you operate. It does not tell you every state where your business may have tax obligations.