Whether you’re a lessor or a lessee, it’s important to understand the different scenarios that you may encounter and know how sales tax applies to the different types of transactions.
Rentals or leases of tangible personal property are generally treated as a standard sale of tangible personal property for sales tax purposes.
Forty-four of the forty-six states plus D.C. that have a sales tax impose tax on rentals of tangible personal property. However, the states do not have a uniform approach to their rules.
State rules generally fall into one of three general categories in taxing true leases of tangible personal property. A true lease is one in which the lessor remains the owner of the property at lease end and the property is returned to the lessor. Title does not transfer to the lessee.
Let’s take a look at the three categories.
Most states tax the lease stream, or the series of period lease/rental payments made by the lessee. The lease/rental is treated as a continuing sale subject to sales tax. The lessor is required to collect and remit the tax on the lessee’s recurring payments.
A few states have caveats about taxing the lease stream based on the duration of the lease term. Sales tax is imposed on the payments of short-term leases in Arkansas less than 30 days regardless of whether the lessor paid Arkansas sales or use tax when the property was purchased.
In Colorado, rentals and leases three years or less are exempt from sales tax if the lessor paid sales/use tax upfront on the property when it was acquired. If the lease term is longer than three years, the lessor can submit an application to the Colorado Department of Revenue to collect tax on lease or rental payments instead of paying tax upfront on the property.
In a handful of states, the lessor pays tax upfront on the purchase price of the tangible personal property and recurring rent/lease payments are exempt from tax.
In Maine, the lessor is liable for sales or use tax when the property enters the state based on the purchase price paid by the lessor for the property. The lessor must report the use tax directly to Maine Revenue Services if sales tax was not paid directly to the vendor when the property was purchased. No sales tax is charged to the lessee.
Similarly, Illinois does not treat the lessee as the end user subject to tax like most states. Lessees do not have a sales tax collection liability under a true lease. Tax is not paid on recurring rental or lease payments on the state administered taxes. However, it should be noted that municipal taxes can change tax collection requirements in Illinois. The city of Chicago imposes its own 9% Personal Property Lease Transaction Tax on lease payments. This is in addition to the tax paid by the lessor on the purchase of the property. In both Illinois and Maine, the lessor cannot claim a resale exemption on the purchase and the tax incurred by the lessor can not be passed through to the lessee as a direct tax.
Ohio has a 30-day rule for rentals and leases of specific items for which tax must be collected upfront at the time the lease is consummated for the entire amount to be paid during the lease period. The rule includes rentals/leases of “tangible personal property to be used by the renter for primarily business purposes” that have a fixed term of more than thirty days or an indefinite term with a minimum period of more than thirty days.
Several states allow lessors to elect whether they want to pay tax on the purchase price the lessor paid to acquire the property or to collect tax on the rental or lease stream. The lessor should consider the present value of the lease stream, length of time the asset will be held, administrative costs and audit issues, as well as whether the property will move between states.
Generally, lessors in California have the option to choose whether tax is based on the purchase price or rental receipts, provided that an election is made in a timely manner. To be considered “timely” for an upfront tax election, the tax must be reported and paid on your sales and use tax return for the first reporting period in which the property is placed into lease service. Otherwise, tax must be reported and paid on the recurring rental payments.
A registered lessor in Michigan can elect to pay tax on the acquisition of the tangible personal property to be leased in Michigan or collect and remit the use tax on the total rental receipts – which include all charges to the lessee for the leased property.
In Rhode Island, a lessor can choose to pay tax as measured by the cost of the property to them upon acquisition. The lessor exercises this election by paying sales tax to the seller or by filing the required use tax return on or before the due date.
A key point to take into consideration is that if the election is made to pay the tax on purchase, no resale exemption can be claimed, the tax can’t be separately stated on the invoice but is a cost of goods sold. Therefore, this decision needs to be made before the periodic lease payment amount is determined. The mobility of the property is another consideration. If property is regularly moved between states, and the upfront election was made, this tax paid is not allowed as a credit in a tax on lease stream state.
Regardless if you’re a lessor or a lessee, you need to understand the sales and use tax implications of rental and lease transactions. Lessors and lessees must communicate and work together, particularly in states with election options, to understand the implications to business and avoid negative tax consequences.