Excise tax

What is excise tax?

Excise taxes are U.S. government-imposed taxes applied to the sale of certain products, activities, and services such as airline tickets, gas, tobacco and cigarettes, tires, alcohol, and gambling. Generally, federal, state, and local tax authorities collect excise taxes at the time of sale or use by a manufacturer or importer, the sale or use by a merchant or retailer, or use by the consumer. For businesses that import goods, excise taxes can also be imposed upon entry into the United States or upon the sale or use after importation.

It is common for a retailer, manufacturer, or importer to pass the tax on to the consumer by including the tax in the retail price of a product. However, the tax is not as evident to the consumer because it is usually not itemized on consumer receipts, as with general sales tax. For this reason, excise tax is also called a “hidden tax.”

Excise taxes can vary widely and are subject to frequent changes. They can be levied as a per-unit tax, such as the per-proof gallon tax on alcohol, or as a percentage of the price, such as a tax added to an airline ticket. For instance, domestic airline passengers pay a 7.5% transportation excise tax on the price of the plane ticket.

Today, while there is a wide range of excise taxes, they account for a relatively small portion of tax collections at the federal, state, and local levels. In fact, excise taxes account for only about 0.4% of federal collections. This number can be attributed to the rapid growth of individual and corporate income tax revenues.

What are examples of excise tax?

A wide variety of products, services, and activities are subject to excise taxes, impacting taxpayers across many industries. As outlined by the IRS, examples of federally imposed excise taxes include taxes on the following:

• Gasoline
  
• Airline tickets
• Heavy trucks and highway tractors
• Indoor tanning services
• Tires
• Tobacco
• Coal
• Alcoholic beverages
• Sports betting
• Other goods and services

What is the purpose of excise tax?

Excise taxes are used by the government as a way to generate revenue and, more importantly, to discourage the consumption of unhealthy products and activities deemed harmful to health and society, such as tobacco products and gambling. For example, excise taxes may be used to suppress cigarette smoking, discourage the purchase of firearms, reduce traffic congestion, or fight pollution. These are penalty-type consumption taxes, commonly called a “sin tax.”

Depending on the type of product or activity being sold, taxpayers may find that sin taxes are imposed at the federal, state, city, and county levels, like alcohol and tobacco products. Businesses pass the sin tax on to consumers. For instance, if you are a retailer selling tobacco products, the consumer will pay the sin tax as part of the purchase price.

The excise tax revenue often goes to either a general fund or trust fund earmarked for a specific purpose related to the taxed product or service, such as funding transportation infrastructure or public health initiatives. For instance, an excise tax on fuel may help fund highway improvements.

Trust fund excise taxes account for roughly three-quarters of total excise receipts, while general fund excise taxes account for the remaining one-quarter.

What are the types of excise tax?

There are two main types of excise tax: ad valorem taxes and specific taxes.

Ad valorem taxes. Ad valorem taxes are imposed as a percent of the total purchase price of goods or services or other defined value of products or commodities. The tax is in proportion to the value of the product or service. The business pays the tax and then usually passes the tax cost on to the consumer at the time of the transition.

For example, an owner of an indoor tanning salon must collect and report to the IRS a 10% excise tax for the services they provide consumers. If the salon charges $50 for a tanning session, the salon owner is subject to a $5 federal excise tax. In general, the owner collects the tax from the consumer when the consumer is paying for the tanning service.

Specific taxes. Specific taxes are imposed per quantity — as a fixed dollar amount on the amount or size of a product. The retailer applies taxes on a per-unit basis — such as gallon, liter, etc. — at the time of purchase. For example, federal excise taxes are imposed on motor fuel or alcoholic beverages and are added to the product's price at the time of transaction.

In addition, the IRS recently reinstated the Superfund Chemical Excise Tax. Manufacturers, producers, or importers of chemical substances need to have a clear understanding to determine if they are subject to the tax, which went into effect July 1, 2022, as required by the Infrastructure Investment and Jobs Act (IIJA). In 1995, the Superfund tax had previously expired.

How do you calculate excise tax?

Calculating excise tax depends on the type of excise tax — that is, ad valorem versus specific tax — among other factors. In general, there are two formulas for calculating either ad valorem or specific tax:

• Ad valorem taxes are imposed as a percent of the total purchase price of goods or services.
  
• Specific taxes are imposed as a fixed dollar amount that applies to the purchase on a per-unit basis, like gallon, liter, etc.

Consider the following examples to explain the excise tax calculation further:

Example #1: Ad valorem taxes

The formula is the price of product × tax rate × quantity = tax liability.

For example, a home’s value is $300,000, and the area’s property tax rate is 6%. The ad valorem property tax would be $18,000 ($300,000 x 0.06 = $18,000).

Example #2: Specific taxes

The formula is quantity × tax per unit = tax liability.

For example, a brewery produces roughly 2,000 liters of beer each day. The federal government charges an excise duty worth $5 per liter. Therefore, they would have to pay $10,000 to sell 2,000 liters of beer each day (2,000 x $5 = $10,000).

Who pays excise tax?

In the U.S., the manufacturer, importer, or retailer typically pays the excise tax to the IRS; to recoup the loss, they pass that cost on to the end consumer. The end consumer may not be aware they are paying hidden taxes, as they are not itemized on the consumer receipt like other indirect tax, for example, general sales tax, use taxes, gross receipts taxes, and value-added taxes (VAT).

Is excise tax the same as sales tax?

Excise tax is not the same as sales tax. They are similar in that they are both an indirect tax. However, businesses must be aware that there are notable differences that apply to the following:

• Application. Excise tax is imposed only on specific goods and services like airline tickets, fuel, tires, indoor tanning services, and gambling. Sales tax is imposed on nearly every sale to a consumer, with a few specific exceptions, such as groceries.
• Calculation. Excise tax can be imposed as a percentage of the cost of a product (ad valorem) or a fixed dollar amount (specific tax). It is typically included in the price of the product or service. Sales tax, however, is calculated as a percentage of the purchase price. The sales tax is itemized on the sales receipt and shifted to the end consumer.
• Tax liability. Excise taxes are imposed at the federal, state, and local levels. However, in the U.S., sales tax is a state and local tax. Sales tax is not imposed at the federal level. Consumers are expected to pay sales tax on all purchases they have made. Should a consumer make a purchase without paying sales tax — for instance, if they bought an item online from an out-of-state retailer that is not required to charge sales tax — then that consumer could instead be subject to use tax. Use tax, which the state or local government usually imposes, is levied on the use, consumption, or storage of goods and services bought without the consumer paying sales tax. The use tax rates are usually the same as sales tax rates.
  

How do you report excise tax?

Any business that provides goods and services subject to excise tax is required to report excise taxes to the IRS by completing Form 720, Quarterly Federal Excise Tax Return. The form must be filed with the IRS each quarter of the calendar year within one month after the end of the quarter.

How do you know if you need to file Form 720?

If the net liability for taxes listed on Form 720, Part I, does not exceed $2,500 for the quarter, then a business must pay the tax due upon filing Form 720. However, if the tax liability is greater than $2,500 for the quarter, semimonthly deposits to the IRS are generally required.

When is excise tax due?

The IRS generally requires that excise taxes be paid semimonthly. The IRS defines a semimonthly period as the first 15 days of a month — the first semimonthly period — or the 16th through the last day of a month — the second semimonthly period.

However, if the net liability for the taxes listed on Form 720, Part I, does not exceed $2,500 for the quarter, then the tax is due upon filing Form 720. Businesses are required to file the form for each quarter of the calendar year.

Are there excise tax exemptions?

There are instances when an entity may be eligible for excise tax exemptions. Such instances include:

• Certain organizations — such as nonprofit hospitals, nonprofit educational organizations, and state and local governments — may be exempt from paying excise taxes for telephone service.
  
• Businesses with idling reduction devices on commercial vehicles may be exempt from federal excise tax under the Energy Improvement and Extension Act (EIEA) of 2008 (PL 110-343).
  
• Certain entities — like nonprofit educational organizations and local state governments — may be able to claim credits or refunds for fuel taxes paid on certain types of fuels used for nontaxable purposes, as outlined in Form 8849. The specific fuel types include kerosene, kerosene for use in aviation, diesel fuel, aviation gasoline, and gasoline.
  

Form 8849, Claim for Refund of Excise Taxes, must be completed to claim a refund for federal excise tax.

Is excise tax deductible?

If a business pays excise taxes deemed an “ordinary and necessary expense” for conducting their business or trade, they can claim excise taxes as a business expense. However, if the excise tax is for a personal expense, it is not deductible. In addition, there are other ways to lower federal excise taxes.