Do I owe sales tax on the fee I pay my equipment lessor to cancel a lease early and get released?

Plain-English summary

R.L. Goodrich & Company (Robert L. Goodrich and Bruce A. Sahs) leases computer equipment under a seven-year lease at $1,169 a month plus applicable state and local sales tax, which it has paid for five years. It now wants to surrender the equipment early, and the lessor requires a payment of $23,824.05 to terminate the lease and give a legal release. The company asked whether that termination fee is subject to sales tax.

The Department said yes — the termination fee is taxable.

• Renting equipment is a taxable sale. Section 1105(a) taxes the receipts from every retail sale of tangible personal property, and a lease of equipment is a taxable "sale" whose periodic charges are taxed (that is why the monthly payments already carried sales tax).
• A "receipt" includes the whole sale price. Under § 1101(b)(3), "receipt" means the amount of the sales price of any property subject to tax.
• A lease-cancellation charge is part of that receipt. It is the Tax Commission's stated policy that a fee charged to terminate a lease is included in the taxable receipt (cf. 20 NYCRR 541.9(c)(1)(i)(c)). Ending the lease is treated as part of the same taxable rental transaction, not a separate, non-taxable payment.
• Result: The lessee must pay state and local sales tax on the $23,824.05 termination fee.

What this means for you

Early-exit and buyout charges on a taxable lease are usually taxable too. If you lease equipment and the monthly rent carries sales tax, the fee to walk away early generally carries tax as well — the Department treats it as part of the receipt from the same rental, not as a tax-free penalty or settlement.

Budget the tax into any lease buyout. When you negotiate to surrender leased equipment, expect state and local sales tax on top of the termination amount at the rate that applied to your rental. A large lump-sum exit fee can carry a meaningful tax cost.

Don't assume "penalty" or "release" labels change the tax. Calling the payment a termination fee, an early-return charge, or the price of a legal release does not make it non-taxable. What matters is that it flows from the taxable lease of tangible personal property.

Common questions

Q: My monthly lease payments already included sales tax. Why is the termination fee taxed too?
A: Because the Department treats the termination fee as part of the taxable receipt from the same lease. It is an additional charge under the rental, so it is taxed like the rent.

Q: Is a fee to buy out or cancel a lease ever tax-free?
A: Not as a general matter for a taxable equipment lease. The Tax Commission's policy is that lease-termination charges are includable in the taxable receipt. Facts that change the nature of the payment could matter, so get advice on your specific arrangement.

Q: Who pays the tax — the lessor or the lessee?
A: The lessee pays the tax; the lessor, as the vendor, collects and remits it, just as it did on the monthly rental payments.

Citations and references

Statute:

• Tax Law § 1105(a) — taxes the receipts from every retail sale of tangible personal property
• Tax Law § 1101(b)(3) — defines "receipt" to include the amount of the sales price of taxable property

Regulation (cited by analogy):

• 20 NYCRR 541.9(c)(1)(i)(c) — treatment of receipts under a lease, cited to support that a lease-termination charge is part of the taxable receipt

Source

• Landing page: https://www.tax.ny.gov/pubs_and_bulls/advisory_opinions/sales_ao_1986.htm
• Opinion: https://www.tax.ny.gov/pdf/advisory_opinions/sales/a86_7s.pdf

Original ruling text

New York State Department of Taxation and Finance
TSB-A-86(7)S
Sales Tax
January 23, 1986

Taxpayer Services Division
Technical Services Bureau
STATE OF NEW YORK
STATE TAX COMMISSION
ADVISORY OPINION

PETITION NO. S850625A

On June 25, 1985, a Petition for Advisory Opinion was received from Robert L. Goodrich
and Bruce A. Sahs D/B/A R.L. Goodrich & Company, 682 Eaton Road, Rochester, New York
14617.
The issue raised is whether Petitioner, as lessee, is required to pay State and local sales tax
on a fee charged by the lessor in consideration of terminating a lease.
Petitioner currently leases computer equipment under a seven year lease agreement. Fixed
monthly payments in the amount of $1,169 plus applicable State and local sales tax has been paid
to the lessor for the past five years. Presently, Petitioner wishes to surrender the equipment to the
lessor and terminate the lease agreement. The lessor requires a payment of $23,824.05 to terminate
the lease and give a legal release to Petitioner.
Section 1105(a) of the Tax Law imposes a sales tax on the receipts from every retail sale of
tangible personal property with certain limited exceptions. Section 1101(b)(3) of the Tax Law
defines the term "receipt" to include the amount of the sales price of any property subject to tax. It
is the policy of the Tax Commission that a fee charged for the termination of a lease is includable
as part of the receipt subject to tax. Cf. Sales and Use Tax Regulations Section 541.9(c)(1)(i)(c).
Accordingly, Petitioner, as lessee is required to pay state and local sales tax on the lease
termination fee paid by it to its lessor.

DATED: January 23, 1986

s/FRANK J. PUCCIA
Director
Technical Services Bureau

NOTE: The opinions expressed in Advisory Opinions
are limited to the facts set forth herein.

RODERICK G. W. CHU, COMMISSIONER
GABRIEL B. DiCERBO, DEPUTY COMMISSIONER
FRANK J. PUCCIA, DIRECTOR
TP-8 (3/83)