If your company is not in the business of renting tangible property, heavy equipment or vehicles, consider yourself at least a little fortunate. While accurate sales tax compliance is never impossible, those companies operating in the rental arena have several challenges unique to their business. In this blog, we will detail some of those challenges and the steps that rental companies must take to stay safe from significant audit exposure.
Based on the wave of legislative and regulatory changes following the SD v. Wayfair Supreme Court decision, a company can now become obligated to collect and remit a state and local sales tax based on its “economic” presence in a state as measured by total sales and/or the number of individual transactions. However, for rental companies, the question has always been one of traditional “physical presence” nexus, which is created by having people and property in a jurisdiction. Since rental companies essentially have “property” in whatever place they rent something to a customer, they are likely to have a broad nexus footprint even if they may not perform a significant amount of business in that state and even if their sales volumes are otherwise not sufficient to cross the applicable economic nexus threshold. In short, a rental company has a tax collection and remittance obligation in most any place its rental property may be found.
Rental transactions are subject to standard state and local sales tax across much of the country, but if a rental company always applies “standard” state and local sales tax rates, it is likely not compliant.
For example, in Alabama, different rules exist with respect to both state and local-level tax. While Alabama applies a standard state sales tax rate of 4%, linen and garment rentals are taxed at the special rate of 2% and motor vehicle rentals at 1.5%. However, the real complexity exists at the local level, where cities and counties are free to apply special rental rates to tangible property, as well as to linens/garments and motor vehicles – and in Alabama, local rates and rules change vary frequently.
A different type of complexity exists in Illinois. State tax and most local sales taxes don’t apply to rental transactions. However, they do apply a “Rental Purchase Agreement Occupation Tax” on “rent to own” transactions where the rental company offers rental terms of four months or less, the rental term is automatically renewable and the customer is allowed to eventually become the owner. Further, in the city of Chicago, there is a special “Personal Property Lease Transaction Tax,” which taxes most leases and rentals at 9%. If that rate seems high, it should. After all, the standard Chicago sales tax rate is only 1.25%.
In Maine, rentals are likewise generally not taxed but this rule does not apply to transactions characterized as a “lease in lieu of purchase,” which occurs when the terms of the contract creates a security interest in the property, provides an option to purchase the property for nominal consideration and the customer must assume responsibility for the disposition of the property at the end of the term. Maine also applies its Service Provider Tax to the rental of video media and equipment and “rent to own” transaction relating to furniture.
In Arkansas all “short term rentals” of tangible property are subject to an additional rental tax of 1% and in Arizona, there is a special transaction privilege tax classification for rental property, leaving localities free to apply unique rental rates, which some definitely choose to do.
Finally, don’t forget Delaware, which famously does not apply a sales tax. However, it does tax leases and rentals at the oddly specific rate of 1.9914%. Accordingly, rental companies in Delaware must obtain a business license and collect/remit this tax on any applicable rental transactions.
Special rental rates and rules often apply to rental transactions involving equipment, heavy machinery and vehicles. States like Connecticut, Washington, and South Carolina all have special taxes on heavy equipment rentals. In North Carolina, counties are enabled to tax, at the additional rate of 1.2%, the short-term lease or rental of heavy equipment. In Texas, a special surcharge applies to both the sale and rental of off-road heavy duty diesel equipment.
The special taxes and fees that passenger vehicle rental companies need to pay are beyond the scope of this article, but understand that if your company rents trucks or vans to haul people or cargo, a number of special rules will apply and those rules will vary in some states based on the nature of the vehicle, its weight and its carrying capacity.
With respect to all these taxes, it’s important to understand what you are renting and how that item might be characterized under the law because the types of items that may be subject to an additional rental tax will vary from state to state. Whether something is or is not “heavy equipment” or a “motor vehicle” in a given state can have major tax implications. Likewise, be cognizant of the fact that providing a human operator with a piece of equipment will often result in the re-characterization of the transaction from a taxable rental to a non-taxable service.
Finally, be sure to understand how deeply your company is invested in the rental business as a number of these additional taxes only apply when the renting company derives 51% or more of its annual revenue from the rental business.
If you look at most sales tax statutes, you will find the terms “retail sale” or “sale” and often, states will define these terms to include leasing and rental transactions. Take this example from Massachusetts:
“Sale” and “selling”, include (i) any transfer of title or possession, or both, exchange, barter, lease, rental, conditional or otherwise, of tangible personal property or the performance of services for a consideration, in any manner or by any means whatsoever.
The impact of including rentals in the definition of “sale” means all the special tax rules applicable to sales of tangible property in a state also apply to rentals unless the law specifically excludes them. For example, in Massachusetts there is a sales tax exemption for articles of clothing up to $175 in sales price. This exemption applies to clothing rentals as well. The same is true across the country, making compliance particularly challenging for companies that rent things like medical equipment and textbooks, which will frequently be subject to both special rental rules and special sales tax exemptions.
Rental companies will frequently charge their customers fees that are related to but not necessarily part of the rental itself. They include charges for:
When these charges are simply rolled into the overall rental price, they will just about always be considered taxable as part of the rental charge. However, state and local taxing distinctions could come into play when the charges are separately stated on the bill or invoice. In many cases, states will still consider these fees to be taxable under the same rates and rules applicable to the underlying rental, but not always. Interest and finance charges are generally not subject to tax and sometimes insurance is not taxable either. In a handful of cases, the taxability may vary based on whether the additional charge is a mandatory or an optional component or the rental. When truly optional, some charges will not be taxed.
Since rental companies are generally responsible for collecting and remitting tax at the time they rent something to a customer, most states hold that their purchases of property to rent may be made tax-free by providing their supplier with a properly completed exemption certificate. However, complexities exist when dealing with the handful of states like Illinois and Maine that don’t tax rentals. So, for example, a rental company doing business in Maine could not buy rental items tax free for resale.
This could be especially tricky for a company that engages in both sales and rentals of the same items. In that case, if an item is initially purchased tax free in Maine for resale but the rental company decides to rent the item instead, it will most likely need to self-assess consumer’s use tax on the cost of the item. A similar challenge applies to rental companies that purchase items that could be rented by customers across multiple states. For example, if a rentor purchases an item in ”State A” for rental using their resale certificate but decides to rent the item to a Maine customer, they will likewise have to self-assess consumers use tax.
Given that we only touched upon vehicle rentals and didn’t discuss long term rentals or leasing, the information in this blog only represents the tip of the iceberg in terms of detailing the sales tax challenges faced by rental companies. However, accurate compliance is not impossible. Rentors who recognize the challenges in front of them and are committed to standing up robust processes that will meet their company’s needs both today and tomorrow place themselves in an excellent position to keep their company safe.