Where the Sale Happens
A dropshipper never touches the product. Goods move from a supplier's warehouse directly to the customer, and the seller's role is placing the order and collecting the payment. For a business with that fact pattern, where a sale is treated as having happened, a question of title rather than of geography, has historically driven where the resulting income is sourced, and sourcing is the question that decides whether that income is taxed by the United States at all.
Title passage as the general rule for purchased inventory
IRC §861(a)(6) sources gross income from the sale of personal property purchased and sold as inventory, meaning purchased for resale rather than produced by the taxpayer, according to where the sale takes place. IRC §862(a)(6) is the mirror provision for income treated as being from sources outside the United States. Neither statute defines where a sale "takes place" in terms of geography or shipping route. The regulations answer that question instead, and they answer it in terms of title.
Treas. Reg. §1.861-7(c) provides that a sale is consummated at the time, and at the place, where the rights, title, and interest of the seller in the property are transferred to the buyer. Where bare legal title is retained by the seller as a formality, for instance to secure payment, the regulation looks past the paper retention of title to where the substance of ownership, meaning the benefits and burdens of ownership and the risk of loss, actually passed. The place named in a contract is a starting point, not the end of the analysis, whenever the underlying facts point somewhere else.
For a genuine dropshipper, this rule matters enormously, because the entire business model can be structured around where title passes. A supplier in one country ships directly to a customer in the United States. If the terms between supplier and dropshipper, and between dropshipper and customer, are drafted and actually followed so that title to the goods passes to the dropshipper and then to the end customer while the goods are still outside the United States, for instance upon the carrier's acceptance of the goods at the point of export, the sale is treated as consummated abroad, and the resulting income is foreign source. Foreign source income is not effectively connected income under the general rule of IRC §864(c)(3), which reaches U.S. source income, and income that is not effectively connected with a U.S. trade or business is generally not subject to U.S. income tax in the hands of a nonresident seller at all.
The regulation's own limit on this
Treas. Reg. §1.861-7(c) contains its own anti-abuse component. Where a sale is structured in a particular manner for the primary purpose of tax avoidance, the regulation does not simply respect the stated terms. It directs that all factors of the transaction be examined, including the negotiation, the execution of the agreement, the location of the property, and the place of payment, to determine where the sale actually occurred in substance. A contract clause stating that title passes at a named foreign port is a fact the analysis considers. It is not, by itself, a conclusion the analysis is bound to reach, particularly where every other fact about the transaction, the marketing to U.S. customers, the U.S.-facing storefront, the U.S. payment processor, and the practical handling of returns and disputes, points toward a transaction genuinely centered in the United States.
This is the distinction worth holding onto. Choosing shipping and title terms deliberately, and then operating consistently with those terms, is a legitimate business decision with a genuine tax consequence attached to it. Writing a title clause into a template agreement that nobody actually follows, while every operational fact about the business points elsewhere, is not a plan. It is one fact among many that a substance-over-form review will weigh, and it tends to weigh against the seller precisely because it looks like what it is.
What "operating consistently with the terms" actually requires
A title passage position is only as strong as the operational facts backing it. Several practical questions tend to decide whether the stated terms will hold up. Who bears the risk of loss while the goods are in transit, meaning who absorbs the cost if a shipment is lost or damaged before it reaches the customer, and does that match what the contract says about title and risk passing at the point of export. How are disputes and refunds handled in practice, since a business that reflexively replaces or refunds damaged goods as a matter of customer service, regardless of where the contract says risk passed, is generating evidence that undercuts its own stated terms. Where are negotiations with the supplier actually conducted, and does the dropshipper have any person or office in the United States involved in placing or managing supplier orders. Whether the stated terms are disclosed anywhere the customer can see them, since a title clause that exists only in an internal supplier agreement and nowhere in the customer-facing terms of sale is weaker evidence of the parties' actual understanding than one reflected consistently throughout the transaction chain.
None of these facts is individually decisive, and a business does not need every one of them to point the same direction to have a defensible position. But a business that has never considered any of them, and is relying entirely on a boilerplate clause copied from a template, has not actually built the position it thinks it has.
The office rule: an override that applies even to inventory
A separate rule can pull the sourcing answer back to the United States even where title genuinely passes abroad under the analysis above. Sometimes called the office rule, and reflected in IRC §865(e)(2) for sales of personal property generally and in the regulations coordinating that provision with §861 and §863 for purchased inventory specifically, the rule provides that where a sale is attributable to a fixed place of business the seller maintains in the United States, the resulting income is sourced in the United States regardless of where title to the property actually passed, unless the property is sold for use, consumption, or disposition outside the United States and a foreign office of the seller materially participated in the sale.
The practical effect is that a dropshipper cannot fully insulate itself from U.S. sourcing purely through title mechanics if it also maintains a U.S. office or fixed place of business through which the sale is made. A seller with genuinely no U.S. office, no U.S. employees, and no U.S. fixed place of business is not reached by the office rule at all, and for that seller the title passage analysis described above is generally the whole inquiry. A seller that has added a U.S.-based operations person, a U.S. returns or prep facility, or any other fixed U.S. presence through which sales are actually transacted has added a second, independent path to U.S. sourcing that a favorable title clause does not close off.
| Fact pattern | Where income is generally sourced | Why |
|---|---|---|
| Title passes abroad, operations match the stated terms, no U.S. office | Foreign source | Treas. Reg. §1.861-7(c) title consummation rule, followed in substance |
| Title clause says goods pass abroad, but operations are entirely U.S.-centered and the clause is not followed in practice | Likely U.S. source | Substance-over-form review under Treas. Reg. §1.861-7(c) looks past the stated term |
| Title genuinely passes abroad, but the seller maintains a U.S. fixed place of business through which the sale is made | U.S. source | Office rule under IRC §865(e)(2), coordinated with §861 and §863 for inventory |
| Goods are manufactured by the taxpayer, not purchased for resale | Allocated based on production activity, not title passage | IRC §863(b), as amended, sources production income by where production activities occur |
A note on manufactured, not merely resold, goods
The title passage rule described above applies to purchased inventory, meaning goods the seller buys from someone else and resells without materially transforming them. A dropshipper who arranges for goods to be manufactured to its own specification, rather than purchasing an existing product line and reselling it, is in a different sourcing regime. IRC §863(b) allocates income from the sale of property produced, in whole or in part, by the taxpayer, based on the location of the production activity, not on where title happens to pass. A business that starts as a straightforward resale dropshipper and evolves into commissioning custom-manufactured goods should treat that change as a change in which sourcing rule applies, not as a variation on the same one.
Why shipping terms are read as tax documents
Commercial shipping terms, commonly expressed using the International Chamber of Commerce's Incoterms rules such as Ex Works, Free on Board, or Delivered Duty Paid, were written to allocate cost, risk, and responsibility between a buyer and seller for commercial purposes, not to answer a tax sourcing question. They are nonetheless the clearest evidence available of where the parties themselves understood risk and control to pass, which is exactly what Treas. Reg. §1.861-7(c) asks about. A shipment sold Ex Works, where the buyer takes responsibility for the goods at the seller's own facility abroad, points toward risk and title passing early and abroad. A shipment sold Delivered Duty Paid, where the seller remains responsible all the way to the customer's address inside the United States, points toward risk and title passing much later, and much closer to, or inside, the United States.
A dropshipper whose actual supplier agreement uses one set of terms, while its customer-facing terms of sale describe something inconsistent, or while its actual practice for damaged and lost shipments does not match either, has created exactly the kind of internal contradiction that a substance-over-form review is built to catch. Aligning the shipping terms actually used with the supplier, the terms of sale shown to the customer, and the way the business genuinely handles loss and damage claims is not a technicality. It is the single most concrete thing a dropshipper can do to make its stated sourcing position match its actual operations.
Sourcing is the second question, not the first
None of the analysis above matters unless the seller has already crossed the threshold of being engaged in a trade or business within the United States under IRC §864(b) in the first place. A nonresident seller who is not engaged in a U.S. trade or business at all is generally not taxed on ordinary merchandise profit by the United States regardless of where title passes, because the flat withholding that applies to nonresidents on U.S.-source income reaches specific categories of passive income, such as dividends, interest, and royalties, and does not reach ordinary business profit absent a U.S. trade or business to which that profit connects. For a seller who has crossed that threshold, meaning the trade-or-business gate is already open, sourcing becomes the operative question, because it decides how much of the seller's income the effectively-connected rule of IRC §864(c)(3) actually reaches. The title passage analysis in this piece assumes that gate question has already been worked through on its own facts, which typically turn on whether the seller has inventory, personnel, or an agent inside the United States, rather than on where title to any given shipment happens to pass.
What the underlying facts should show before the position is taken
A defensible position rests on a written record, not a recollection of intent. That record should include the actual terms of sale as presented to customers, the actual terms with suppliers governing where and when title and risk pass, evidence of how the business has handled damaged or lost shipments in practice, confirmation of whether the seller has any office, warehouse, contractor, or agent inside the United States and what that person or facility actually does, and a description of where sales are negotiated and orders are placed. Building that file before a filing position is taken, rather than after a question arises, is what separates a documented conclusion from a hopeful one, and it is the only way the substance-over-form component of Treas. Reg. §1.861-7(c) can actually be satisfied rather than merely asserted.
This is general information about how the title passage sourcing rule and its office-rule override apply to purchased inventory sold by a nonresident, as of the date written. It is not advice on any particular business's facts, and where a sale actually consummates, and whether an office rule applies, depends entirely on the specific operational record a given seller can produce.