Traversing the Murky Waters of Illinois’ New Sales Tax on Leases

Keith Staats, JD Special Counsel, Duane Morris LLP
Deciphering Today's State & Federal Tax Law

Legislation modifying the sales taxation of most leases of tangible personal property (TPP) became effective Jan. 1, 2025. The legislation conformed the Illinois sales taxation of leases of TPP to the manner in which all other states tax such leases.

Under the old law, when a lessor of TPP purchased an item for lease purposes, the lessor paid tax on the purchase price of the item to the seller—no sales tax was imposed on the subsequent lease of that TPP.

Now, purchases of TPP to be leased are no longer subject to an upfront tax on the purchase price. The items are purchased tax free by providing a certificate to the seller attesting that the purchase is for lease purposes. Notably, this certificate is a modified version of existing form CRT-61, which is also used for purchases for resale. The lease payments by the lessee to the lessor are now subject to tax.

Makes sense, right? The incidence of the tax is just shifted. Well, as with everything related to sales tax in Illinois, it’s not quite that simple—here’s why.

WHAT TAX RATE APPLIES TO LEASE PAYMENTS?

The Illinois Retailers’ Occupation Tax (ROT) is imposed at the state level at a rate of 6.25%, along with the various locally imposed ROTs that are administered and collected by the Illinois Department of Revenue (IDOR). Tax rates vary by city, sometimes even within a city because of unincorporated areas.

In general, Illinois is an “origin” state when it comes to sales tax. In Illinois, the tax rate imposed is the combined state and local tax rate in effect at the selling location—and now the leasing location. For example, if I go to a copier company to rent a printer or photocopier for my office and pick up the machine at the company, the tax rate is the rate in effect at the copier company’s location—because that’s where the lease transaction “occurred.”

However, IDOR made a last-minute amendment to the leasing legislation that made things more complicated for certain lessors. The amendment provides that if the lessor (copier company) delivers the machine to me (the lessee), and there are periodic payments for the rental, the tax rate charged is the tax rate in effect at my location. Therefore, instead of charging the tax rate in effect at the copier company’s location, they have to determine the tax rate in effect at the location of each of their customers, charge that tax, and report the proper tax amount on a Schedule ST-2 form attached to their sales tax return.

RELATED PARTY TRANSACTIONS

Further complicating matters are related-party lease transactions. Let’s consider a business that has multiple legal entities. If one legal entity, Company A, purchases items of TPP and leases those items to another related legal entity, Company B, the lease transactions between related parties are now subject to sales tax on the lease payments.

This result isn’t a glitch—it’s a feature of Illinois’ sales tax law. Unlike corporate income tax, where there’s a unitary theory of taxation and intercompany activities are disregarded between related companies that are unitary in nature, sales tax has always been different. The general rule in sales tax is that legal entities are respected in the case of transactions between related companies. Transactions between related entities are subject to the normal sales tax rules. As a result, Company A, a lessor of construction equipment to related Company B, is required to charge sales tax on the rental charges to Company B. And similar to my copier company example, if Company A delivers the equipment to Company B, the tax rate will be the rate in effect at the location where the equipment is delivered.

Under the old law, Company A, the lessor of equipment, would’ve been required to pay sales tax on the acquisition cost of the equipment. However, under the new (current) law, Company A will no longer have to pay sales tax on the acquisition cost of the equipment.

Of course, this explanation always raises the question: Shouldn’t there be a credit against the tax that Company A paid before Jan. 1, 2025, when it acquired the equipment that’s being leased after that date? In my opinion, the answer should be yes. In fact, the version of the legislation I drafted had a one-time credit to deal with items purchased before Jan. 1, 2025, that are being leased after that date. However, IDOR rewrote my draft legislation and eliminated the credit, likely because of what they perceived as the fiscal impact of the credit in the first year.

You see, there’s a limited credit under the existing regulations. Under this credit, when Company A decides to sell off the equipment in its inventory that it acquired before Jan. 1, 2025, and upon which it paid tax upon acquisition, it can keep the sales tax it charges on that subsequent sale up to the amount of the sales tax paid when the equipment was acquired. Obviously, that limited credit isn’t going to fully compensate Company A for the amount of sales tax paid on acquisition of the property.

LEASE VS. SERVICE: WHAT’S THE TRUE OBJECT OF A TRANSACTION?

Now, let’s talk trash (not trash talk). Specifically, let’s discuss trash containers—the containers that my trash service provides me as part of my trash collection service, or the dumpsters that an apartment building, restaurant, or other business is provided for their trash. Knowing what we know under the new law, do trash companies now have to charge tax on the “rental” of the trash containers by figuring out how much is paid each month for trash service and the portion of the charge for the containers? In unofficial conversations I and other members of the Illinois CPA Society’s State and Local Tax (SALT) Committee had with folks from IDOR’s legal staff, we were provided with an answer that, in my opinion, is both legally correct and practical.

IDOR’s lawyers stated that customers are purchasing a service (trash collection) and containers and dumpsters are the collection vessels used in the provision of that service. In looking at the nature of, or true object of, the transaction, people aren’t renting containers—they’re obtaining a trash disposal service. So, because Illinois generally doesn’t tax services, there’s no taxable rental in those situations.

No doubt, there will be other issues and questions like this that come up as the new law is implemented. Currently, IDOR is working on rules, has issued information bulletins, and begun publishing general information letters in response to inquiries about specific situations. I’d advise checking IDOR’s website regularly for answers. Also, if you’re faced with a question you’d like addressed, please reach out to me directly or post the question on ICPAS Connect, as the SALT Committee monitors that online forum.

Related Content:

• Another Attempt at ‘Leveling’ Illinois’ Sales Tax: Despite the Illinois General Assembly’s latest legislative move to further level the playing field for out-of-state retailers, problems persist.
• Hashing Out Illinois’ New Sales Tax on Leases: Following years of negotiations, changes to the sales tax on leases of tangible personal property will go into effect on Jan. 1, 2025.