Frequent travelers are painfully familiar with the high taxes that many localities and special taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. districts levy on rental cars. Many can recall at least one instance when the tax burden rivaled or even exceeded the cost of the car itself. Even by these standards, however, Chicago is an outlier, imposing a lease tax on cars rented in the suburbs when the renter is a city resident.
Local rental car taxes are of a relatively recent vintage; as of 2004, only three localities nationwide imposed a tax expressly on car rentals. Today, 42 states impose rental car taxes, and at least 15 of them authorize local governments to impose their own taxes on car rentals. It is not uncommon for a motorist to be taxed by the state, the locality, and a special airport district or other special tax authority. Chicago, however, stood out in its effort to impose its tax on transactions taking place outside the city’s boundaries.
Earlier this week, the Illinois Supreme Court struck down the practice, reversing the Illinois Appellate Court. “Given the number of local governmental units, particularly in the Chicago area … unrestrained extraterritorial exercise of the powers of taxation and zoning and in other areas could create serious problems,” the Court observed.
While the tax was in place, any Chicago resident who rented a vehicle within three miles of the city limits was assumed to be using the vehicle in the city at least half the time, and thus subjected to the tax absent written proof that the vehicle was intended for use outside the city.
Tax nexus is a controversial and increasingly significant issue made even more complex by the interconnectedness of the modern economy. Transactions often implicate many states and jurisdictions: if, for instance, a company based in Massachusetts purchases a digital product license used by engineers in Minnesota for cloud computing software produced in California, and delivered via a server based in Virginia, which government(s) may levy a tax on the transaction? Similar challenges bedevil a range of corporate taxes. But car rentals?
As the Supreme Court wrote, “The fact is that, at the time of the lease transaction, the use of the leased vehicle has not taken place and may never take place within Chicago’s borders. There is no delivery of the leased vehicles into Chicago, and the lease transactions take place wholly outside Chicago.”
The Illinois Supreme Court got it right. If localities can tax outside their own borders based on probabilistic use, taxation can quickly become arbitrary, and taxpayers are left with no good options. If Chicago’s tax burden is too onerous, residents may choose to go elsewhere. If Chicago’s taxes can follow them even if they are not engaging in meaningful economic activity in Chicago and have no ability to affect policy outcomes in Chicago, they have little recourse.
Except for the courts. Of course, it was the rental car companies who went to court, but the ruling is a victory for all taxpayers.
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