The advertisements are easy to find. Attorneys in Montana claim they can help you avoid sales tax. You’ll find frequent posts discussing those claims on forums for RV enthusiasts or owners of other expensive vehicles. Some say it sounds too good to be true. The attorneys offering the services invariably include language like, “You should consult a tax advisor in your home state to determine all the tax consequences.” Looking for information from the Illinois Department of Revenue (IDOR) itself, a decisive answer isn’t an easy find. So what’s the deal?
To back up, it’s important to understand sales tax and use tax and how they are assessed in Illinois. Sales tax is straightforward. You buy something in Illinois, the state collects sales tax on that purchase (6.25% currently). The tax might be higher in some locations because cities and counties add their own sales tax on top. Use tax isn’t something people encounter as frequently, so often they aren’t as familiar with it. Use tax is assessed on the privilege of using goods or services within the state of Illinois. The rate is equal to the sales tax rate (6.25%) less any sales tax paid on the purchase of the item. The idea, in other words, is to catch transactions that would otherwise slip through and avoid sales tax.
The idea behind the Montana LLC is this. You set up a single-member LLC in a state like Montana that does not have a sales tax. You avoid paying sales tax, therefore, by making your purchase in Montana. But when you bring that vehicle back home to Illinois, can you likewise avoid paying use tax? That’s the kicker.
The attorneys who offer these services are usually fuzzy on this point. They advise clients to consult attorneys or other tax advisors in their home states.
The question, specifically, is whether a vehicle owned by a foreign LLC qualifies for an exemption from use tax. There are various exemptions in Illinois. Organizations that do not have to pay sales tax (charities, for example) likewise do not have to pay use tax. Items purchased for resale are also exempt. In the case of these foreign LLCs, the targeted exemption is that for nonresidents. Use tax is assessed on the privilege of using property within the state, but it is only assessed on residents. A truck driver, for example, does not owe use tax simply because his or her driving route goes through Illinois. The rationale behind the out of state LLC tax avoidance is thus that since the owner of the vehicle, the LLC, is not a resident of Illinois, the use of the vehicle within the state does not incur use tax.
Does IDOR actually see it that way?
The clearest guidance comes from a decision rendered in 2010 by the Illinois Department of Revenue Office of Administrative Hearings. IDOR subsequently published the decision with the names and other identifying information removed. The facts of the case are fairly typical for these sorts of things. The taxpayer set up a Montana LLC to try to avoid Illinois sales tax on his vehicles. Although he tried to claim at trial that he was not a permanent Illinois resident (he traveled frequently with his RV) the court found that because he had an Illinois drivers license, received utilities bills at an Illinois address, had a bank account in Illinois and paid income tax to Illinois, he was indeed an Illinois resident. The court further found that since the LLC had been created purely to avoid taxes, it could be treated as a disregarded entity for tax purposes. In doing so they drew upon precedent established by the US Supreme Court that although a corporation is typically treated as an entity distinct from its owners, that distinction can be disregarded when the corporate form is a sham or unreal. The Department ruled that since this LLC existed solely to hold title to vehicles in an attempt to avoid paying use tax on them and since the taxpayer had commingled his own assets and the LLC’s to such an extent that the two could not be separated, the LLC could be disregarded for tax purposes and the taxpayer was the actual owner of the RV. And since the Department had also ruled that the taxpayer was in fact an Illinois resident, thus he owed use tax on the RV.
Although every situation is of course unique and your circumstances may not match the above case entirely, it is reasonable to conclude that similar cases, when individuals form LLCs to hold title to vehicles in states without sales tax to attempt to avoid Illinois sales and use taxes, will be treated the the same way by IDOR the above case. To be specific, the taxpayer’s case in that decision relied upon a two-prong strategy: claiming that the vehicles were owned by the Montana LLC and claiming as a sort of backup that he was not an Illinois resident in any case. In both cases he tried to avoid taxation through the nonresident exemption to the Illinois Use Tax Act. Tellingly, in both cases he did not prevail and it is reasonable to expect that similar strategies will be met with similar results. An LLC which seems to have been organized solely to avoid taxes is likely to be disregarded for tax purposes and someone claiming to be a nonresident despite having an Illinois driver’s license, receiving utility bills to an Illinois address and paying Illinois income tax, is unlikely to be recognized as a nonresident by IDOR.
In short, though it’s impossible to make a statement covering every possible scenario, in general it seems safe to say that attempting to avoid sales tax by holding title to vehicles through a Montana LLC (or an LLC incorporated in another state without sales tax) is unlikely to prevail if challenged by IDOR.
Horowitz Law Offices regularly represents taxpayers before the Illinois Department of Revenue, the IRS and the Chicago Board of Finance. You are welcome to contact us at (312) 787-5533 or firstname.lastname@example.org