If I lease a motor vehicle under a true lease and then buy it before the lease ends, do I get credit against the purchase tax for the sales/use tax already paid on my lease payments?

Plain-English summary

This General Information Letter answers a question from a married couple who leased a vehicle under a "true lease," prepaid sales/use tax as part of the lease, and then terminated the lease early to buy the vehicle outright. They were charged additional sales/use tax on the purchase and asked the Department to reimburse them, arguing they had already paid tax on lease payments that were never used because the lease ended early.

The Department explained that Illinois taxes motor vehicle leases differently from many other states. There are two types of leasing arrangements for Illinois sales tax purposes: conditional sales (typically identified by a nominal, e.g. one-dollar, buyout option, which make all receipts taxable under the Retailers' Occupation Tax from the outset) and true leases (which generally have no buyout provision, or only a fair-market-value buyout option). Under a true lease, the lessor — not the lessee — is deemed the end user of the vehicle and owes Use Tax on its own cost price of the vehicle. Illinois does not tax the lease payments (receipts) themselves. Because of this, a lessee leasing a vehicle for a term of more than one year is not directly subject to tax on the lease payments, although leasing companies commonly pass along their Use Tax liability to the lessee by contract, and this reimbursement is reported on Form RUT-25-LSE.

The Department then addressed the couple's actual situation: when a lessee under a lease of more than one year decides to purchase the vehicle being leased, that purchase is a separate, taxable transaction. The lessor/seller incurs Retailers' Occupation Tax liability on the sale, and the lessee/buyer incurs Use Tax liability on the purchase. Critically, the lessee cannot apply the lessor's earlier Use Tax payment (from when the lessor originally acquired the vehicle for leasing) as a credit against the lessee's own Use Tax liability on this later purchase. In other words, the tax paid in connection with the lease and the tax owed on the subsequent purchase are treated as two distinct tax liabilities, and no offset exists between them.

What this means for you

If you are leasing a vehicle under a true lease

Under a true lease, you as the lessee are generally not directly taxed on your lease payments — the legal tax liability sits with the lessor, who owes Use Tax on the vehicle's cost price. However, most leasing contracts require you to reimburse the lessor for that Use Tax liability, and this is typically reflected as a tax component built into your lease payments and reported on Form RUT-25-LSE. Review your lease contract to see how this reimbursement obligation is structured.

If you buy out your leased vehicle before the lease ends

If you decide to purchase the vehicle you are leasing (whether at the end of the term or by terminating early), that purchase is treated as a brand-new, separate taxable transaction. You, as the buyer, will owe Use Tax on the purchase price, and the seller (your former lessor) will owe Retailers' Occupation Tax on the sale. You will not receive credit against this new tax liability for the tax amounts associated with your unused lease payments, even if the lease ended before its scheduled term.

Common questions

Q: I terminated my vehicle lease early and bought the car. Can I get a refund or credit for the sales/use tax already built into my remaining, unused lease payments?
A: No. This GIL states that a lessee may not apply the lessor's prior Use Tax payment on the initial lease/sale of the vehicle against the lessee's own Use Tax liability for the subsequent purchase of that vehicle. The lease-related tax and the purchase-related tax are separate liabilities.

Q: Who legally owes the tax during a true lease — the lessor or the lessee?
A: The lessor. Under 86 Ill. Adm. Code 130.220, lessors of tangible personal property (including motor vehicles) under true leases are deemed the end users of the property and owe Use Tax on their own cost price of the vehicle. Illinois does not directly tax the lease payments themselves.

Q: Why do my lease payments seem to include a tax charge if the lessee isn't legally liable for the tax?
A: While the legal tax liability belongs to the lessor, leasing companies commonly require lessees to reimburse that Use Tax liability by contract. This reimbursement is what typically shows up on your lease statement and is reported by the lessor on Form RUT-25-LSE.

Q: What happens tax-wise when I buy the vehicle I'm leasing?
A: Under 86 Ill. Adm. Code 130.2013, purchasing a leased vehicle after a lease term of more than one year is a separate, taxable transaction: the lessor/seller owes Retailers' Occupation Tax, and you as the lessee/buyer owe Use Tax on that purchase, independent of tax already associated with the lease.

Citations and references

• 86 Ill. Adm. Code 130.220 — lessors under true leases are deemed end users and owe Use Tax on their cost price of the leased property
• 86 Ill. Adm. Code 130.2013 — a lessee's purchase of a leased motor vehicle is a separate taxable transaction (Retailers' Occupation Tax for the seller, Use Tax for the buyer)
• 2 Ill. Adm. Code 1200.110 — procedures governing Private Letter Rulings (PLRs)
• 2 Ill. Adm. Code 1200.120 — General Information Letters (GILs) are not binding statements of Department policy
• Form RUT-25-LSE — used to report the lessor's Illinois Use Tax liability on leased vehicles

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/sales-tax/2017.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/sales-tax/2017/st-17-0020-gil.pdf

Original ruling text

ST 17-0020-GIL 06/09/2017 MOTOR VEHICLES
Lessors of tangible personal property, including motor vehicles, under true leases in Illinois are
deemed end users of the property to be leased. As end users of tangible personal property
located in Illinois, lessors owe Use Tax on their cost price of such property. See 86 Ill. Adm.
Code 130.220 and 86 Ill. Adm. Code 130.2013. (This is a GIL.)

June 9, 2017

Dear Xxxxx:
This letter is in response to your letter dated February 6, 2017, in which you requested
information. The Department issues two types of letter rulings. Private Letter Rulings (“PLRs”) are
issued by the Department in response to specific taxpayer inquiries concerning the application of a
tax statute or rule to a particular fact situation. A PLR is binding on the Department, but only as to the
taxpayer who is the subject of the request for ruling and only to the extent the facts recited in the PLR
are correct and complete. Persons seeking PLRs must comply with the procedures for PLRs found in
the Department’s regulations at 2 Ill. Adm. Code 1200.110. The purpose of a General Information
Letter (“GIL”) is to direct taxpayers to Department regulations or other sources of information
regarding the topic about which they have inquired. A GIL is not a statement of Department policy
and is not binding on the Department. See 2 Ill. Adm. Code 1200.120. You may access our website
at www.tax.illinois.gov to review regulations, letter rulings and other types of information relevant to
your inquiry.
The nature of your inquiry and the information you have provided require that we respond with
a GIL. In your letter you have stated and made inquiry as follows:
My wife NAME and I are the owners of a 20XX VEHICLE (VIN ###). We originally
leased the vehicle from COMPANY (COMPANY). The original vehicle value when we
leased it on April 18, 2015, was $$$. The Illinois sales/use tax on that amount would
have been $$. In connection with the lease, we prepaid sales/use tax of $$$ on May
21, 2015. On September 4, 2015 we terminated our lease and purchased the vehicle
from COMPANY for $$. At that time 34 additional lease payments, for which the sales
tax already had been paid, still remained. In registering the title in our name, we were
charged an additional amount of $$ in sales/use tax. We were not given any credit for
the prior unused lease payments. The total amount paid has been $$. This is $$ more
than what should have been the total sales/use tax paid.
Please reimburse us for this amount. I enclose copies of our lease, verification of
purchase and proof of sales/use tax payments. Thank you for your assistance. You
can contact us at the address above, by email (EMAILADDRESS) or by telephone ###.

DEPARTMENT’S RESPONSE:

ST 17-0020-GIL
Page 2

Please note that the State of Illinois taxes leases differently for Retailers’ Occupation Tax and
Use Tax purposes than the majority of other states. For Illinois sales tax purposes, there are two
types of leasing situations: conditional sales and true leases. A conditional sale is usually
characterized by a nominal or one dollar purchase option at the close of the lease term. Stated
otherwise, if lessors are guaranteed at the time of the lease that the leased property will be sold, this
transaction is considered to be a conditional sale at the outset of the transaction, thus making all
receipts subject to Retailers’ Occupation Tax. A true lease generally has no buyout provision at the
close of the lease. If a buyout provision does exist, it must be a fair market value buyout option in
order to maintain the character of the true lease.
Lessors of tangible personal property under true leases in Illinois are deemed end users of the
property to be leased. See 86 Ill. Adm. Code 130.220. As end users of tangible personal property
located in Illinois, lessors owe Use Tax on their cost price of such property. The State of Illinois
imposes no tax on lease receipts. Consequently, a lessee of a motor vehicle in Illinois for a lease
term of greater than one year is not subject to tax. However, while the legal incidence of the tax is
imposed only on the lessor, it is common for leasing companies to require reimbursement of their
Illinois tax liability from the lessee by contract. A review of your motor vehicle leasing contract will
likely reflect this reimbursement requirement. It is the lessor’s Illinois Use Tax liability (borne
contractually by the lessee) that is reported on the RUT-25-LSE.
If a lessee decides to purchase a motor vehicle that he or she is leasing for a lease term of
greater than one year, then this is a separate, taxable transaction and the lessor/seller incurs
Retailers' Occupation Tax liability on this sale and the lessee/buyer incurs Use Tax liability on this
sale. See 86 Ill. Adm. Code 130.2013, which addresses this issue. A lessee may not apply the
lessor’s prior Use Tax payment on the initial sale of the motor vehicle against the lessee’s Use Tax
liability for the subsequent sale of the vehicle to the lessee.
I hope this information is helpful. If you require additional information, please visit our website
at www.tax.illinois.gov or contact the Department’s Taxpayer Information Division at (217) 782-3336.

Very truly yours,

Samuel J. Moore
Associate Counsel

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