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When Should Manufacturers Pay Sales Tax on a Lease?

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Should manufacturers handle sales and use taxes differently for leases versus purchases? As with anything else in sales and use tax, it depends on the state. Manufacturers lease many items that are used throughout their plants, so it is important to know how to handle these transactions from a sales and use tax perspective.

A lease agreement usually involves two parties -- the lessor (person that owns the property and is renting it out) and the lessee (person renting the property). In general, a lease or rental agreement can be handled one of three ways.

  1. In most states, the lessor purchases the property with a resale certificate and collects the tax on the lease payments from the lessee.
  2. Some states allow the lessor to choose how they want to handle the lease. They can either pay the tax when they purchase the property and not charge tax to the lessee, or they can purchase the property with a resale certificate and then charge tax to the lessee on the lease amount.
  3. In a few states, leases are not taxable to the lessee therefore the lessor has to pay the tax when they purchase the property.

Under all three scenarios, it is important to remember that the tax base can include charges such as personal property tax and finance charges.

When entering into a lease agreement, it is also important to know whether the lease will be a capital lease or an operating lease.

  • Capital Lease: If you lease an item that you will purchase at the end of the lease for a nominal amount, this is considered to be a capital lease. 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: If you lease an item that will not be purchased at the end of the lease, this is an operating lease and tax typically will be due on each lease payment.

Don’t overlook the sales tax obligations when entering into a lease agreement. Understand the type of lease agreement you sign and make sure to research how your state will handle tax payments on lease transactions.

Share your stories! Have you ever run into trouble with a state over sales tax on a lease agreement? Which states have the most confusing sales tax guidelines for leases?

About the Author: Lauren Stinson,CMI, is Principal and National Leader - Sales & Use Tax at Cherry Bekaert LLP; a national CPA and consulting firm ranked as one of the top 25 in the country. Previously, Lauren was Owner and President of Windward Tax, a sales and use tax consulting firm. She has more than 25 years experience working with manufacturers on sales and use tax issues. Lauren is pleased to share her expertise with SalesTaxSupport readers as the Manufacturing contributor in SalesTaxSupport’s Industry blog, as well as the Georgia Sales Tax contributor in the States blog.

Comments or questions may be submitted by using the on-page "Comment" feature, subject to disclaimer at bottom of page. More specific questions or requests may be sent to Lauren directly using the orange "REQUEST" link on Lauren's Firm Profile page.

Other recent “Manufacturing & Distribution” posts by Lauren Stinson, CMI:

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