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David Machemer Published in Journal of State Taxation – The Lessor’s Burden: Tax Challenges for Illinois Equipment Leasing

Journal of State Taxation, Volume 37, Issue 3, May 28, 2019 08/06/2019
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Illinois’ tax treatment of leases is an anomaly when compared to most other jurisdictions.[1] The general rule in most jurisdictions is to impose sales tax on the receipts collected from the lessee, the actual user of the equipment. However, Illinois differs, at least in the context of a long-term lease (i.e., more than one year), by treating the lessor of tangible personal property as the “user” of the property. As such, the lessor is subject to Illinois Use Tax (“use tax”).[2] Consequently, Illinois’ unique treatment presents many challenges for lessors. First and foremost, Illinois imposes the tax the lessor who does not have the day-to-day control over the equipment. The fall out of this typically surfaces when leasing mobile property like over-the-road trucks or aircraft which travel across state lines in interstate commerce.

Additionally, in the context of exemptions, it is sometimes unclear whether a lessee’s exemption “flows through” for the lessor’s use. This can create additional uncertainty and headaches for lessors. These nuances are further exacerbated by the fact that not all leased property is treated the same under Illinois law. For instance, motor vehicles which are rented for less than one year are subject to the Automobile Renting Occupation and Use Tax (“AROT”).[3] Another example,  “rent-to-own” merchandise,  is subject to the “Rental Purchase Agreement Occupation and Use Tax”[4] and is exempt from the traditional retailers’ occupation tax (“ROT”) and use tax.[5]

This article provides an overview of leasing and discusses some of the sales tax challenges that lessors face when leasing property in Illinois. Unless noted otherwise, , this article focuses on the application of Illinois retailer’s occupation tax and use tax to leased tangible personal property.[6]

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What Is a Lease?

The fundamental question that must first be asked before determining the sales tax consequences of a transaction is whether the property is truly being leased. Under Illinois law, “true leases” and “conditional sales,” often referred to as “$1 outs,” are subject to different tax treatment.[7] A conditional sale is traditionally characterized by a nominal or dollar purchase option at the end of the term. Essentially, conditional sales are “finance” or “loan” transactions disguised as a “sale.” This “sale” is subject to Illinois ROT (i.e., sales tax).

Conversely, a “true lease” does not always include  an automatic buy-out provision at the end of term, and if one does exist, the buyout must be for fair market value. Under Illinois law, because lessors are deemed to be the end users of the property being leased, they are subject to the use tax upon the acquisition cost of the property.[8]

Lessors’ Challenges

(1) Illinois Does Not Have a Resale Exemption Applicable to a True Lease Transaction

In jurisdictions where the tax is imposed on the lessee, the lessor should habitually provide a resale certificate to the seller of the equipment to be leased. This is because most jurisdictions impose tax on the lessee and the state grants  a “resale” exemption to lessors acquiring property for resale or re-lease. In Illinois, however, a lessor should never provide the vendor or manufacturer with a resale certificate in a true lease transaction.[9] Rather, the lessor must pay the applicable tax charged by the vendor, or alternatively, if the vendor otherwise fails to charge tax, the lessor must self-assess and remit use tax on its Illinois return.[10]

Despite Illinois’ imposition of use tax on the lessor, and not on the lessee’s lease receipts, a lessor can recoup its tax costs through private contract reimbursement with its lessee.[11] Lessors should  accomplish this by drafting a tax reimbursement provision in the lease agreement. Thus, a properly drafted provision enables lessors to recoup the costs incurred from its up-front use tax obligation.

(2) Handling a Lessee’s Exemption Status

Any time a lessee claims the lease transaction is exempt from Illinois tax, the lessor must pay strict attention to the documentation provided by its lessee. This is because a lessee’s “exempt” status does always flow through to the lessor and exempt the lease transaction. In my prior experience working in-house for a large leasing company, this was one of the most common issues that caused friction between the lessor and lessees. Often, charitable and religious institutions, who are generally exempt from their purchases and leases in most jurisdictions, unexpectedly find a “reimbursement for use tax paid” on their invoice.[12] These “federally exempt” entities often attempt to rely on the general rule that lease receipts are not subject to tax, but fail to understand Illinois taxes leases differently and that the lease agreement requires them to reimburse the lessor for its use tax obligations. If lessors seek to collect this reimbursement from lessees, specific “reimbursement” language should be used in the lease agreement.

Nevertheless, some entities’ status does through to the lessor and exempt the lease transaction. For example, lessors who are leasing property to qualifying persons who have been issued an “E” number by the Illinois Department of Revenue are exempt from use tax.[13] These persons are limited to governmental bodies and exempt hospitals.[14] In the context of hospitals, only certain purchases will qualify—namely computers and communications equipment utilized for hospital purpose and equipment that are used to diagnose, analyze, or treat hospital patients.[15]

(3) Application of Illinois’ “Rolling Stock” Exemption to Leased Property

Another common exemption which flows through for the lessor’s benefit on its purchase of equipment is the rolling stock exemption. The term “rolling stock” includes the transportation vehicles of any kind of interstate company for hire (railroad, bus, airline, trucking, etc.). Effective August 24, 2017, to qualify for the exemption, the motor vehicle or trailer must be used to transport persons or property for hire, the purchaser must certify that the motor vehicle or trailer will be utilized by an interstate carrier for hire who holds an active USDOT number with the carrier operation identified as “interstate” and the operation classification as “authorized for hire,” “exempt for hire,” or both, and for motor vehicles, the gross vehicle weight rating must exceed 16,000 pounds.[16] Prior to this amendment, the lessor was required to certify that the vehicles were utilized more than 50% of its miles or trips outside Illinois.[17]

Previously, the rolling stock exemption required the lessor to certify as to the lessee’s status and consequently,  placed the lessor in an uncomfortable position of certifying as to a lessee’s usage of the motor vehicle. Fortunately, the recent law change has lessened this burden by eliminating the actual mileage/trip usage. Moreover, there are means for lessor to verify a lessee’s carrier status by visiting the U.S. Department of Transportation, Federal Motor Carrier Safety Administration’s “Safety and Fitness Electronic Records (SAFER) System.”

Notably, a lessor can claim this exemption if the vehicle is used by an interstate carrier for hire between points in Illinois, if in transporting, for hire, the persons or property being transported originate or terminate outside Illinois on other carriers.[18]

(4) Passenger Motor Vehicles Subject to Lease of More Than One Year

Another difference in the way Illinois taxes leased equipment is in the context of certain leased “qualifying motor vehicles” which recently changed.[19] Prior to 2015, Illinois taxed the entire capitalized cost of a leased motor vehicle, less any applicable trade-in credit. In 2015, Illinois enacted Public Act 98-628 which amended its definition of “selling price” of “qualifying motor vehicles” to include the amount due at lease signing, plus the total amount of payments over the term of the lease. The Act also eliminated trade-in credits used to reduce the selling price of a motor vehicle and the tax remained due at the time of the lessor’s acquisition of the motor vehicle. The intent of this legislation was tax savings for lessees and level the playing field with other state’s leasing laws.[20]

However, unfortunately, this change also led to the imposition of post-lease charges to be collected by the lessor. Specifically, “the lessor who purchased the motor vehicle assumes the liability for reporting and paying the tax on those amounts directly to the Department in the same form (Illinois Retailers’ Occupation Tax, and local retailers’ occupation taxes, if applicable) in which the retailer would have reported and paid such tax if the retailer had accounted for the tax to the Department.”[21] (Emphasis added.) Consequently, this language converts the post-lease collection charges into a ROT obligation for the lessor, rather than a use tax. While this change may sound subtle, this treatment conflicts with Illinois’ traditional treatment of true leases by requiring the lessor to act as a retailer and collect the tax from the lessee, rather than acting as the “user” of the equipment.

This new treatment raises the question of whether home rule authorities, such as City of Chicago and Cook County, whose Ordinances adopt Illinois’ definition of “selling price,” have the authority to impose its titled use tax on post lease charges who are prohibited from imposing ROT on titled property.[22] Conversely, there is no restriction on home rule authorities from imposing a use tax on titled property. However, Illinois’ recent change treats the post-lease charges as a ROT to be collected by the lessor from the lessee. Both the City of Chicago and Cook County ordinances impose a tax on titled property.[23],[24]

So what issues should lessors be aware of in home rule jurisdictions? First and foremost, there is a question of whether the home rule authorities have the authority to collect the tax imposed on post lease charges. Both Chicago and Cook County adopt the State’s definition of “selling price.”[25] Thus, because post-lease charges are treated as ROT under Illinois’ definition, there is an argument that the home rule jurisdiction does not have authority to enforce the collection of such tax under Article VII, Section 6 of the Illinois Constitution of 1970 or the home rule authorities delegated by the General Assembly.[26]

Second, even if the home rule authorities have the authority to impose the titled use tax on post-lease charges, there is the practical issue of compliance. For example, if a lessor purchases a vehicle from a Chicago dealer, the dealer must report the Chicago titled use tax on the ST-556-LSE. Accordingly, when the lease ends, the lessor would remit Chicago titled use tax on post lease charges on the LSE-1 when it uses the rate from the original ST-556-LSE form. However, if a vehicle moves into Chicago mid lease term, and a Chicago titled use tax was not due on the original ST-556-LSE, the lessor now becomes obligated to remit the applicable Chicago titled use tax on a separate Chicago titled use tax return. The lessor also purportedly has the responsibility to remit applicable tax due on any post-lease charges at the conclusion of the lease. In this situation, unfortunately, the Chicago tax cannot be remitted on the LSE-1, because per IDOR’s instruction, it must use the rate on the original ST-556-LSE return.[27]

This is especially challenging where Chicago does not currently have a form where a lessor can report tax on post-lease charges. Thus, it is unclear how lessors can comply, or alternatively, whether Chicago is aware of the potential limitations with its enforcement of a titled use tax on post-lease charges. Cook County has published a form for lessors to report titled use tax on post-lease charges.[28] Again, however, this doesn’t answer the question of whether the County even has the constitutional authority to impose the tax, but at the least, it has issued a form for lessors to report the tax, if legally due.[29]

(5) Illinois’ Recently Enacted Legislation Subjects “Rent-to-Own” Equipment to the Rental Purchase Agreement Occupation and Use Tax Act

Leases for rent-to-own equipment are not subject to Illinois’ ROT or use tax. Rather, rent-to-own equipment leases must comply with the Rental Purchase Agreement Occupation and Use Tax Act.[30] Under this Act, rent-to-own equipment leases refer to agreements “for the use of merchandise by a consumer for personal, family, or household purposes for an initial period of four months or less that is automatically renewable with each payment after the initial period and that permits the consumer to become the owner of the merchandise.”[31] If a rent-to-own lease agreement falls under the jurisdiction of this Act, then lessors are able to escape the general treatment of leases and instead tax the rental receipts.[32]


An equipment lessor leasing property in Illinois must be aware of Illinois’ unique treatment of leases in general and also, the specific rules applicable to different types of equipment or it will undoubtedly find itself with unforeseen tax liability. Lessors should also consider establishing a review process for any exemption certificate related to a leasing transaction in Illinois. Due to Illinois’ unique rules, a one size fits all answer does not work in Illinois. Additionally, although not discussed in this article, lessors leasing property within the City of Chicago must also be aware of Chicago’s Personal Property Lease Transaction. This tax, unlike Illinois’ treatment, is a tax on lease receipts. Thus, lessees in Chicago are subject to the Chicago Lease Transaction Tax and, most likely, reimbursement of the lessor’s use tax.

[1] But see California in the context of Mobile Transportation equipment and Maine generally for other jurisdictions that treat leases similarly to Illinois unique treatment. Cal. Code Regs. 18 §1661; M.R.S. 36 §1811, Maine Instructional Bulletin No. 20.

[2] 86 Ill. Admin. 130.2010; see also GIL 16-0067 (Dec. 27, 2016).

[3] See 35 ILCS 155/1 et seq. (“AROT”).

[4] See 35 ILCS 120/2-5(43).

[5] See 35 ILCS 105/3-5(38), 35 ILCS 120/2-5(43).

[6] There are instances where leased property may be subject to a different tax in Illinois, and if mentioned herein, such instances will be noted.

[7] See GIL 16-0067 (Dec. 27, 2016).

[8] See 86 Ill. Admin Code 130.220 (a).

[9] 86 Ill. Admin Code 130.220.

[10] Id.

[11] See ST 15-0018 GIL (Mar. 18, 2015).

[12] See Private Letter Ruling ST 92-0688 (Dec. 21, 1992).

[13] See 35 ILCS 105/3-5(22), (23), (31).

[14] 86 Ill. Admin. Code 130.2011 & 130.2012.

[15] Id.; see also General Information Letter Ruling ST 15-0018 IL (Mar. 18, 2015).

[16] P.A. 100-321 (eff. Aug. 24, 2017).

[17] See 35 ILCS 115/2d.

[18] 86 Ill. Admin. Code 130.340(d).

[19] The provisions discussed in this article do not apply to all motor vehicles. Specifically, “qualifying motor vehicles” are defined as: (1) first division motor vehicles; and (2) second division vehicles that are self-contained motor vehicles designed or permanently converted to provide living quarters for recreational, camping, or travel use, with direct walk through access to the living quarters from the driver’s seat; motor vehicles of a van configuration designed to transport not less than 7 and not more than 16 passengers; and motor vehicles having a gross vehicle weight rating (GVWR) of 8,000 pounds or less. Notably, this Act carved out terminal rental adjustment clause (“TRAC”) leases and truck tractors and semi-trucks which are often used to transport persons or property across state lines.

[20] Ill. P.A. 98-628.

[21] 35 ILCS 120/1, 35 ILCS 105/2.

[22] 55 ILCS 5/5-1006; 65 ILCS 5/8-11-1.

[23] Chi. Code §3-28-010; Cook County Ord. §74-272. Note, other home rules impose a titled use tax, for example, City of Springfield. Springfield Code, Article V §100.42–100.999.

[24] Chi. Code §3-28-036; 65 ILCS 5/8-11-6(c).

[25] Notably, Chicago has an agreement with the Illinois Department of Revenue that requires any dealer located in Cook County or a surrounding collar county to collect applicable Chicago titled use tax at the time of the retail sale and report the tax on the state form ST-556-LSE. Chi. Code §3-28-303; Cook County Ord. §74-271. Conversely, Cook County does not have a similar type of agreement with IDOR and the titled use tax must be paid directly to Cook County and remitted on a separate Cook County return.

[26] Ill. Const. Art. 7 §6; 55 ILCS 5/5-1006; 65 ILCS 5/8-11-1.

[27] It has come to our attention that if the same rate is not used on the forms, the LSE-1 will be rejected.

[28] Schedule C of the Cook County Titled Use Tax Return.

[29] Notably, we have learned that the County may send notices directly to the lessee for the collection of Cook county titled use tax. However, in light of Illinois’ treatment of leases and the discussion above, this treatment is impermissible.

[30] 35 ILCS 180/5.

[31] 35 ILCS 180/5.

[32] See

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