As outlined in the published bulletin, starting January 1, 2025, the State of Illinois will classify the rental, leasing and licensing (collectively, “leasing”) of tangible personal property (“TPP”) as a retail sale for purposes of the retailers’ occupation tax (sales) and use tax (hereinafter, the “lease tax”). This reclassification means that businesses leasing TPP in the ordinary course of their business must now register with the Illinois Department of Revenue (the “Department”) and remit tax on the lease receipts. However, if a locality already imposes a specific tax on leases or rentals of TPP (like the City of Chicago’s Personal Property Lease Transaction Tax), the lease receipts sourced to that locality are exempt from the State’s lease tax. The tax rate applied to the lease receipts will generally be determined using the same sourcing rules used for traditional sales of TPP.
As illustrated through the hypothetical questions and responses below, this tax reclassification of leases creates several implications which may not be immediately apparent.1
Q: Starting January 1, 2025, licensed software meeting the state’s “5-part test” (35 ILCS 120/2-5(49)(1)) will be exempt from the state’s lease tax. Does this mean that software companies licensing software meeting the state’s 5-part test should start as of January 1, 2025, reporting their lease receipts on taxable software on the Illinois Form ST-1, Sales and Use Tax and E911 Surcharge Return, and then claim a deduction for the exempt receipts?
A: Yes, because licensed prewritten software meeting the state’s 5-part test is now exempt from Illinois sales or use tax, as opposed to previously being excluded from state taxation in Illinois, starting January 1, 2025, licensors of taxable software will now report their Illinois sales receipts from licensed software and then claim a deduction for exempt sales. SaaS transactions are excluded from Illinois sales and use tax, provided the transactions do not include a transfer of tangible personal property. Thus, receipts from SaaS transactions are not “taxable receipts” to be reported on Form ST-1.
NOTE: The above answer is also likely true for leases subject to the state’s local lease tax exemption. Under this exemption, “property that is subject to a tax on lease receipts imposed by a home rule unit of local government if the ordinance imposing that tax was adopted prior to January 1, 2023,” is exempt from the Illinois state lease tax. 35 ILCS 120/2-5(49)(2). The reporting of exempt software and local lease receipts should allow Illinois to track how much tax escapes state taxation each year.
Q: If a lease is exempt from Chicago’s lease tax, will the lease receipts then be subject to Illinois lease tax?
A: No, not likely. As far as we can determine, the Department has not yet addressed this specific question. However, because the local lease exemption applies to property “subject to” local lease tax and not property “taxed by” a locality, property that is subject to a local lease tax but qualifying for a local lease tax exemption should remain exempt from the state’s lease tax. However, property exempt from Chicago’s lease tax because it is used more than 50% outside the city (see Mun. of Chicago 3-32-050(A)(1)), should most likely be subject to the state lease tax because this property is leased and used predominantly outside of Chicago.
Q: Because the lease tax applies to pre-existing leases, will a lessor be able to collect the state lease tax from existing lessees?
A: It depends. Many lease agreements have language allowing a lessor to charge and collect taxes that may be due on the lease receipts from its lessee. However, if a lease agreement has a fixed lease amount and no contractual language allowing a lessor to charge and collect tax on top of the fixed lease payment, then the lessor may be in the unfavorable position of having to pay the Illinois lease tax and absorb the cost of tax with no way of passing on the expense to its lessee. Lessors should review their existing lease agreements to make sure they can pass on the lease tax to their existing lessees.
Q: What is the “86-54” credit and when and how can a lessor claim the credit?
A: The “86-54” credit refers to Department Information Bulletin, FY 86-54 (June 1986), which explains how lessors of property can earn a tax credit or refund to help offset the upfront tax paid upon the purchase of TPP inventory for leasing in Illinois. FY 86-54 was later codified at Ill. Admin. Code tit. 86, § 130.2013(h)(2). Pursuant to section 130.2013(h)(2), persons in the business of both renting and selling TPP may claim a credit or refund when selling leased property no longer required as inventory. A lessor who incurs an Illinois sales tax liability on the sale of leased property can take a credit or claim a refund against that liability for any Illinois sales or use tax the lessor paid when the lessor purchased the item for lease in Illinois. The credit or refund cannot exceed the amount of sales tax incurred by the lessor when the lessor sells the item in a retail sale in Illinois.
NOTE: Although there is no offsetting tax credit specifically for the Illinois sales or use tax previously paid on leased equipment subject to the new lease tax, because leases are now included within the definition of a “sale at retail,” an argument can be made that the sales tax a lessor collects on its lease payments is a tax imposed on the subsequent sale of the leased equipment and, thus, eligible for the 86-54 credit. Consequently, there is a position that a lessor should receive a tax credit in an amount not to exceed the lease (sales) tax collected on its lease payments. However, this position could be considered contrary to the purpose of the 86-54 credit, and if the 86-54 credit did apply, the credit or refund would likely be limited to the tax collected on the first lease payment (and not all subsequent lease payments), which could be de minimis in amount.
Q: If a lessor leases a piece of construction equipment to a lessee pursuant to a renewable month-to-month lease and the lessee moves the equipment from jobsite to jobsite during the lease term, which tax rate should the lessor use each month?
A: If the lessee picks up the construction equipment from the lessor’s business location, then the lessor should use the tax rate for the lessor’s business location (origin sourcing). However, if the lessor delivers the equipment to the lessee’s business location, then the lessor should use the tax rate for the lessee’s business address (destination sourcing). If the lessor delivers the equipment to a jobsite, then the lessor should, most likely, use the jobsite address provided by the lessee as the tax location (again, destination sourcing). While the property’s location for tax situs is not altered by the leased property’s intermittent use at different locations, delivery of equipment for use at a jobsite may not constitute an intermittent use. However, the lessee’s primary business address may be a reasonable substitute (or better option) if the address is available to the lessor, and it is known to the lessor that the equipment will be located at the lessee’s primary business address between projects. If a lessor has GPS tracking capabilities for its equipment, then this information may also be a credible substitute for sourcing the equipment to its primary destination for purpose of taxation, if the property is delivered to the lessee and subject to recurring periodic lease payments.
- The following questions and responses are based on our reading and understanding the statute and the guidance published to date. The Department, the City of Chicago, or a court of law may not agree with all of the conclusions set forth herein.
Client Alert 2025-005