When a finance company buys heavy trucks and trailers from a dealership to lease to customers under a TRAC (terminal rent adjustment clause) lease, does the dealership charge sales tax on that purchase, and who owes tax on the lease payments?

Plain-English summary

A finance company that offers TRAC (terminal rent adjustment clause) leases and traditional financing for heavy commercial trucks and trailers asked the Illinois Department of Revenue how sales tax applies to its business. Under its typical deal, the finance company buys the truck or trailer from a dealership (taking title itself) and then leases it to a customer, who has the option at the end of the lease to buy the vehicle at a stated residual value or return it.

The Department explained that Illinois splits leasing into two categories for tax purposes: a conditional sale, usually marked by a nominal or one-dollar buyout that effectively guarantees the property will be sold, which makes the whole transaction taxable as a sale from the start; and a true lease, which has no buyout (or only a fair-market-value buyout), under which the lessor is treated as the end user of the property and owes Use Tax only on its own cost to acquire it. Illinois imposes no Retailers' Occupation Tax or Use Tax on rental/lease receipts themselves, so a lessee incurs no state tax liability on the lease payments.

TRAC leases get their own statutory backstop: under Section 3-201.1 of the Illinois Vehicle Code, a TRAC arrangement for motor vehicles or trailers does not, by itself, turn the deal into a sale merely because the rental price can be adjusted up or down based on the vehicle's resale value. TRAC leases of heavy trucks and trailers are therefore analyzed under the general true-lease/conditional-sale rules in 86 Ill. Adm. Code 130.2010, not as automatic sales.

The ruling also flags a special rule for automobiles: lessors of automobiles under true leases with an initial lease period longer than one year owe Use Tax on the purchase price even if the lease also has renewal options for periods of less than a year — those renewals count as extensions of the original lease, not brand-new short-term leases, so they don't pull the deal into the separate Automobile Renting Occupation and Use Tax Act (which applies to autos leased one year or less).

Bottom line for the dealership-to-lessor sale: the dealership incurs Retailers' Occupation Tax liability on its sale of the truck to the finance company (reported on Form ST-556 for vehicles), and the finance company, as the true-lease lessor, then owes Use Tax on its own purchase cost — either paid to a registered supplier at purchase or self-assessed and remitted to the Department (with credit available if tax was already paid on the same property to another state).

What this means for you

Equipment and vehicle finance/leasing companies

If you buy trucks or trailers from a dealer and lease them out under a true lease (no guaranteed buyout, or only a fair-market-value buyout), you — not your lessee — are the party who owes Illinois Use Tax, and it's computed on what you paid the dealer, not on the stream of lease payments you'll collect. You must either pay Use Tax to a registered supplier at purchase or self-assess and remit it yourself; a credit is available if you already paid tax on the same property to another state.

Dealers selling to leasing companies

When you sell a truck or trailer to a company that will lease it out, you incur Retailers' Occupation Tax on that sale just as you would on any retail sale, and you report it (for vehicles) on Form ST-556. You can't contractually shift that reporting and remittance responsibility to the buyer.

Businesses using TRAC leases specifically

A TRAC clause — where the rental price is adjusted based on the vehicle's eventual resale value — does not by itself convert your lease into a taxable sale under Illinois Vehicle Code Section 3-201.1. Your TRAC lease is still analyzed under the ordinary true-lease/conditional-sale framework, so whether it's taxed as a sale up front turns on whether the buyout is nominal (conditional sale) or fair-market-value (true lease).

Accountants and tax professionals

Watch the one-year line for automobile leases: an initial term over one year with a true lease keeps Use Tax based on the lessor's cost, and shorter renewal options tacked onto that same lease don't reset the clock into the separate Automobile Renting Occupation and Use Tax Act. Also remember lessors cannot legally "pass through" their Use Tax as a tax to the lessee, though private contract terms can require reimbursement.

Common questions

Q: Does the dealership charge sales tax when it sells a truck to our leasing company?
A: Yes. The dealership incurs Retailers' Occupation Tax liability on that sale, just like any other retail sale, reported on Form ST-556 for vehicles.

Q: If the dealership's sale to us is taxed, do we then also owe tax when we lease the truck to our customer?
A: Under a true lease, you as the lessor owe Use Tax on your own purchase cost (paid to the supplier or self-assessed), but Illinois imposes no additional Retailers' Occupation Tax or Use Tax on the lease/rental payments themselves. Your lessee therefore has no state tax liability on the lease payments.

Q: Does using a TRAC (terminal rent adjustment) clause automatically make our lease a taxable sale?
A: No. Under 625 ILCS 5/3-201.1, a TRAC provision that lets the rental price be adjusted up or down based on the vehicle's resale amount does not, by itself, create a sale. The lease is still analyzed under the normal true-lease vs. conditional-sale rules.

Q: We lease automobiles for an initial term of more than a year but allow shorter renewal options — does that change anything?
A: No. Lessors of automobiles under an initial lease term over one year owe Use Tax on the purchase price even if renewal options run for less than a year; those renewals are treated as extensions of the original lease, not new leases, and the deal is not pulled into the separate Automobile Renting Occupation and Use Tax Act.

Q: What kind of sales tax account do we need for these transactions?
A: The GIL directs general questions like this to the Department's regulations and Taxpayer Information Division rather than prescribing a specific account type in the abstract; the applicable account depends on whether you are acting as a retailer, a lessor self-assessing Use Tax, or both.

Citations and references

Regulations and statutes:

• 86 Ill. Adm. Code 130.2010 (true lease vs. conditional sale)
• 86 Ill. Adm. Code 130.2010(b) (lessor deemed end user under a true lease)
• 86 Ill. Adm. Code 130.220 (Retailers' Occupation Tax on sales to lessors)
• 86 Ill. Adm. Code 150.310(a)(3) (credit for Use Tax paid to another state)
• 35 ILCS 155/1 et seq. (Automobile Renting Occupation and Use Tax Act, for autos leased ≤1 year)
• 625 ILCS 5/3-201.1 (Illinois Vehicle Code; TRAC leases do not by themselves create a sale)
• 2 Ill. Adm. Code 1200.110 (Private Letter Ruling procedures)
• 2 Ill. Adm. Code 1200.120 (General Information Letters; non-binding on the Department)

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/sales-tax/2022.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/sales-tax/2022/st22-0005-gil.pdf

Original ruling text

ST-22-0005 03/15/2022 LEASING
Lessors of automobiles for initial lease periods in excess of one year are subject
to Use Tax liability on the purchase price of those automobiles even if the lease
agreements provide for renewal options of less than those initial lease periods.
See 86 Ill. Adm. Code 130.2010. (This is a GIL.)
March 30, 2022
Dear NAME:
This letter is in response to your letter dated February 17, 2022, 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:
This letter is written on behalf of COMPANY1 (“COMPANY1”), a STATE
limited liability company, which operates under the trade name
“COMPANY2.” COMPANY1’s tax identification number is ##-#######.
COMPANY1 is a finance company of heavy commercial trucks and trailers
that offers TRAC Lease and traditional financing options to customers of a
heavy truck dealership with locations in Illinois it partners with. All of
COMPANY1’s transactions take place electronically.
Typically, when a TRAC Lease is originated COMPANY1 will purchase the
leased asset (which will be titled to COMPANY1) from the dealership. The
TRAC Lease will provide the lessee the option to purchase the leased
asset at a stated residual value or return the leased asset to COMPANY1
at the end of the lease term.
We are writing today due to receiving conflicting answers to our questions
from speaking with multiple employees of the Illinois Department of
Revenue over the phone the past few months. In an effort to assure its
compliance COMPANY1 would like to confirm the proper sales tax
treatment for TRAC Lease transactions as described above in the state of

COMPANY1
Page 2
March 30, 2022
Illinois we would like to request a written ruling from the Illinois
Department of Revenue on the following questions. When the lessor
purchases a heavy truck from the dealership to be leased under a TRAC
Lease as described above, should the dealership collect and remit sales
tax on the sale from the lessor or is the sale exempt from sales tax? If the
purchase of the heavy truck by the lessor from the dealership is exempt
from sales tax then would the lessor be responsible for collecting and
remitting sales tax on the TRAC Lease upfront at the lease origination or
over the term of the lease as lease payment are made? What kind of sales
tax account is required for transactions as described?
We greatly appreciate your assistance and look forward to hearing back
from you.
DEPARTMENT RESPONSE:
The State of Illinois taxes leases differently for Retailers’ Occupation Tax and
Use Tax purposes than most 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 a conditional sale at the outset of the
transaction, thus making all receipts subject to Retailers’ Occupation Tax. See 86 Ill.
Adm. Code 130.2010. A true lease generally has no buy out provision at the close of
the lease. If a buy out provision does exist, it must be a fair market value buy out option
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 130.2010(b). 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 rental receipts. Consequently, lessees incur no tax liability.
Regarding terminal rent adjustment clause or TRAC leases, Section 3-201.1 of
the Illinois Vehicle Code states: “Terminal rent adjustment clause leases. In the case of
motor vehicles or trailers, a transaction does not create a sale or a security interest
merely because it provides that the rental price is permitted or required to be adjusted
under the agreement either upward or downward by reference to the amount realized
upon sale or other disposition of the motor vehicle or trailer.”
The guidelines set out in 86 Ill. Adm. Code 130.2010 are applicable to all true
leases of tangible personal property in Illinois except for automobiles leased under
terms of one year or less, which are subject to the Automobile Renting Occupation and
Use Tax found at 35 ILCS 155/1 et seq. As stated above, in the case of a true lease,
the lessors of the property being used in Illinois would be the parties with Use Tax
obligations. The lessors would either pay their suppliers, if their suppliers were
registered to collect Use Tax, or would self-assess and remit the tax to the Department.

COMPANY1
Page 3
March 30, 2022
If the lessors already paid taxes in another state with respect to the acquisition of the
tangible personal property, they would be exempt from Use Tax to the extent of the
amount of such tax properly due and paid in such other state. See 86 Ill. Adm. Code
150.310(a)(3). Lessors of automobiles for initial lease periods in excess of one year are
subject to Use Tax liability on the purchase price of those automobiles even if the lease
agreements provide for renewal options of less than those initial lease periods. These
types of leases are not subject to taxation under the Automobile Renting Occupation
and Use Tax Act. The renewal options for periods of less than one year are not treated
as new leases but are merely extensions of the initial lease period.
Under Illinois law, lessors may not “pass through” their tax obligation to the
lessees as taxes. However, lessors and lessees may make private contractual
arrangements for a reimbursement of the tax to be paid by the lessees. If lessors and
lessees have made private agreements where lessees agree to reimburse lessors for
the tax paid, then lessees are obligated to fulfill the terms of the private contractual
agreements.
Illinois retailers who sell tangible personal property to purchasers who act as
lessors under true leases incur Retailers' Occupation Tax liability on the sales of that
property. See 86 Ill. Adm. Code 130.220. Retailers in Illinois report the retail sale of
automobiles on Form ST-556. The retailers making those sales are responsible for the
proper reporting of the tax.
Those retailers may not contractually shift their
responsibility for properly completing those forms and remitting the tax incurred on
those sales. If the purchases of the property to be leased occur in Illinois, the
purchasers must pay their Use Tax liability to the retailer at the time of purchase. The
retailers are then allowed to retain the amount of Use Tax paid to reimburse themselves
for their Retailers' Occupation Tax liability incurred on those sales. If the purchases of
the property to be leased occur outside of Illinois and the retailers from whom those
purchases are made are not registered to collect Illinois Use Tax, the purchasers must
pay the appropriate amount of Use Tax incurred directly to the Department on Form
RUT-25.
Please note that the analysis is different if the items being purchased for lease
qualify for the alternative selling price established under P.A. 98-628, which is only
allowed for leases with a defined period and for motor vehicles of the first division and
certain motor vehicles of the second division. As a result, the alternative selling price
would not apply to open-end leases (i.e. leases with a defined initial period with the
option to continue the lease on a month-to-month or other basis). For further
information, please see Informational Bulletin FY 2015-03.
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,

COMPANY1
Page 4
March 30, 2022
AKO

Alexis K. Overstreet
Associate Counsel