When is Sales Tax Due on a Lease?
Learning the facts around sales tax implications on leased products and services can save many headaches and prevent unwanted surprises. Unfortunately, as with most sales tax issues, the laws can be quite complex and vary from state to state.
Generally, if tangible personal property (TPP) is taxable when purchased, it is typically taxable when leased. Additionally, if an exemption applies to the purchase, it will generally apply to the lease. From here, sales tax on leases becomes more complex.
Here are key questions to answer when determining the tax implications of leased tangible personal property.
What are your state's requirements on leases?
A lease agreement usually involves two parties -- the lessor (person that owns the property and is leasing it out) and the lessee (person leasing the property). In general, a lease or rental agreement is handled one of three ways.
1) In most states, the lessor purchases the property with a resale certificate and collects the tax on the stream of lease payments from the lessee.
2) Some states allow the lessor to choose how to handle the lease. Either pay the tax when the property is purchased and not charge tax to the lessee; or purchase the property with a resale certificate and then charge tax to the lessee on the lease amount.
3) In a few states, a lease is not taxable to the lessee, therefore the lessor has to pay the tax when the property is purchased or the lease is subject to rental tax instead of sales tax.
What is the timing of the tax due?
When entering into a lease agreement, it is important to know whether the lease will be a capital lease or an operating lease.
Capital Lease: Items are leased with intent to purchase at the end of the lease for a nominal amount. The true object of the transaction is a sale. In most states, tax will be due on a capital lease when the sale is made, usually at the beginning of the lease.
Operating Lease: Items are leased with no intent to purchase at the end of the lease. Tax typically will be due on each lease payment.
How does the State tax ancillary charges?
Lease agreements often include additional expenses such as finance charges and interest, insurance or maintenance fees. Check the invoices to see how these charges appear. Often interest and finance charges are not taxable, if these charges are separately stated on the invoice. The taxability of insurance and maintenance fees often depends if these services are required or optional.
Does the lease include any services?
If the lease includes more than just tangible personal property, the transaction may be categorized as a “bundled” transaction, which often can result in non-taxable services becoming taxed services if the charges are not separately itemized.
Is it a lease with an operator?
Sales tax implications frequently change when the lease includes an operator. In many cases, the states will consider these to be services vs. leases of equipment. Then the taxability will rest with the taxability of the service. Some factors that drive the taxability decision include: who has possession of the property; who has control of the property; scope of services to be performed.
Rule of thumb
Do not overlook the sales tax obligations when entering into a lease agreement. Understand the terms of the lease agreement and make sure to research how your state will handle tax payments on lease transactions.
For answers to questions about specific lease agreements, contact the sales tax experts at Cherry Bekaert.