How to Avoid Sales Tax-Legally

Five states do not levy sales taxes-Alaska, Delaware, Montana, New Hampshire, and Oregon. Oregon is the winner here

Ever feel like you're being taxed to death? Everyone feels that way on April 15, but another way to feel the pinch is to buy a collector car and stop by your local DMV to get it licensed.

Consider a hypothetical SCMer taxpayer. He finds the right Ferrari Daytona coupe owned by a motivated seller. After modest negotiations (and thorough pre-purchase inspections by Ferrari experts to confirm its authenticity, history, and mechanical, body, chassis and cosmetic condition), he writes a check for $250,000. A few days later, he drives the Daytona to his nearest DMV office, and collapses when he gets the registration bill.

If our taxpayer lives in San Francisco, he's facing one of the highest sales taxes in the country. California's base sales tax rate is 7.25%, but local governments and special districts are allowed to add to that. As a result of the add-ons, the sales tax rate in San Francisco is 8.5%, which adds $21,250 to the cost of the Daytona. Granted, this is a lot more than the typical state's 6%, but it's not even the highest sales tax rate in California. That honor goes to the city of Southgate, in Los Angeles County, which tops out at a whopping 9.25%.

And the expenses don't stop there. California's annual vehicle licensing fee is 0.65% of a car's value, adding another $1,625 to the cost of our taxpayer's Ferrari. But California is in a deep budget mess. At this writing, a news report claimed that a tentative budget deal would raise this fee to 2% of the car's value. That would cost our taxpayer another $5,000 every year.

There are no limits to these taxes, and the same percentages apply to all collector cars, and they mount up as the value of the car goes up. As you would expect, our taxpayer would love to know how to avoid some or all of these additional taxes.

Use tax backs up sales tax

Sales taxes are levied only in retail transactions. The seller collects the sales tax from the buyer and sends it to the state. But it's too burdensome to require private sellers to do that. So every state that imposes a sales tax backs it up with a use tax.

In private transactions, the purchaser is legally required to report the purchase and pay a use tax, which is levied at the same rate as the sales tax. Obviously, very few purchasers bother to do that, and use tax revenue is dramatically limited. But use tax is very easily collected when licensing the vehicle.

Dealers have their own snags

Sales and use taxes are not imposed on wholesale transactions. Car dealer purchases are exempt, as they will collect a sales tax from the retail purchaser of the car. Some car collectors have discovered they can get licensed as a car dealer rather inexpensively. Dealer status allows them to exempt their purchases from sales and use tax, but it has its shortcomings.

First off, dealer status makes your car insurance more difficult. Your "inventory" can't be properly insured under a consumer policy, and sneaking it may allow the insurance company to deny your claim on the basis of fraud, just when you need the coverage most.

As a dealer, you have to collect sales tax and file reports with the state when you sell a car, creating an administrative burden and accounting expense.

But the greatest financial concern is that dealer status can make you lose out on capital gains taxation when you sell the car. Sales from a dealer's inventory are taxed as ordinary income, currently a 35% maximum tax rate. That is a lot more than the bargain basement 15% federal capital gains rate, previously reported by "Legal Files."

It's a pretty easy audit issue for the IRS. "Mr. Taxpayer, we know you wouldn't lie to your state government about your sales and use tax status-that would be a crime. If you had purchased this vehicle for investment purposes, you would have paid sales or use tax. You didn't do that, so it must be inventory, right?"

And try getting the auditor to believe that you bought the Daytona as inventory, but later decided to keep it as an investment, and didn't realize that doing so meant you had to pay use tax to your state.

Find a tax shelter state

If our taxpayer is willing to do it, he can avoid the sales and use tax by parking his Daytona in another state, at least for a while. California law, which is probably typical, imposes a sales or use tax only on cars purchased for use within the state. That is, California can't tax the Daytona until it comes into California. Think of it this way. If you owned a vacation home in another state and bought a car to leave there for use when you stayed at your vacation home, no one would expect California to levy a tax on a car registered in the other state.

Yacht owners have been doing this for years. It is fairly common practice for California yacht owners to take delivery of their yachts at the Ensenada, Mexico, yacht harbor and leave them there long enough to escape California sales tax. But leaving the Daytona in Mexico isn't very appealing for many reasons, and our taxpayer would prefer to keep it in the United States. But just placing it in another state will expose it to sales or use tax in that state. There may be some savings because California has a very high sales tax rate, but it isn't a complete victory. What our taxpayer needs is a tax haven state for his Daytona.

There are five states that do not levy sales taxes-Alaska, Delaware, Montana, New Hampshire, and Oregon. Oregon is the winner here because it has very appealing vehicle registration laws. Under Oregon law, you can register your Daytona in Oregon if you are a resident of Oregon, or if the Daytona is garaged in and used in Oregon. In other words, the Daytona can be registered in Oregon if it is an Oregon resident, no matter where you live. And, to make it even more alluring, your initial Oregon title and licensing fees, regardless of value, come out to about $120, and that licenses the car for two years.

You can go home again

This may seem rather far-fetched, but it's really quite doable. All our taxpayer needs to do is find a place to store the Daytona in Oregon, and a local contact, and he can avoid the California taxes and license fees altogether. And having a car to drive in Oregon enables him to enjoy great roads and scenery-and the tax savings can pay for plane trips back and forth.

But at some point, our taxpayer is going to want to bring the Ferrari home to California. Can he ever afford to do so?

California law is quite helpful in this regard. No sales or use tax is imposed when a California resident imports a car that he owned, licensed, and used in another state. To prevent subterfuges, two requirements are imposed: (1) the car must have been registered in the other state for at least 90 days (until recently, the requirement was one year); and (2) the owner must have actually used the car in the other state throughout its stay. Just parking it there for a few days won't be enough. Our taxpayer will need gas receipts, airfare and lodging expense receipts, etc., to establish that he actually used the Daytona in Oregon throughout the 90-day period.

Out-of-the-box thinking

This may seem like a complicated solution, but "Legal Files" has assisted several collectors in legitimately avoiding sales and use taxes in this manner, the more notable ones involving a Porsche Carrera GT and a McLaren F1. At those levels, the savings can run into six figures.

The Pacific Northwest is a great place to visit, and the roads and scenery are fantastic. You can take advantage of upcoming car club events to plan your local usage. Then, after your Oregon-resident collector car has been properly "seasoned," you can work on getting it into your home state in a nontaxable manner.