Excise Tax: What It Is and How It Works

Key takeaways
* Excise taxes are levied on specific goods, services, or activities (e.g., fuel, tobacco, alcohol, airline tickets).
They are usually paid by businesses but commonly passed on to consumers through higher prices.
Two main types: ad valorem (percentage of value) and specific (fixed amount per unit).
“Sin taxes” are excise taxes aimed at products with high social costs.
Certain retirement-tax penalties (excess contributions, early withdrawals, missed RMDs) are also treated as excise taxes.

What is an excise tax?

An excise tax is imposed on particular goods, services, or transactions rather than on general income or broad consumption. Governments at the federal, state, and local levels may levy excise taxes. They can be designed to raise revenue, discourage consumption of harmful goods, or fund specific programs.

How excise taxes work

• Collectors and payment: Businesses that produce, import, or sell taxed items typically remit the tax to the government. Many businesses incorporate the tax into the retail price, so consumers effectively pay it without seeing a separate line item.
• Reporting: Businesses that collect federal excise taxes generally file Form 720 (Quarterly Federal Excise Tax Return) and remit payments quarterly.
• Purpose: Besides revenue, excise taxes can be used to reduce consumption of goods with adverse social or health effects (e.g., tobacco, alcohol, indoor tanning).

Types of excise taxes

Ad valorem excise taxes
* Charged as a percentage of the value of a good or service.
* Examples: IRS levies a 10% excise tax on indoor tanning services; other ad valorem rates have applied to firearms, airline tickets, and heavy trucks. Property taxes are another example of a value‑based levy.

Specific excise taxes
* Charged as a fixed dollar amount per unit (per pack, per gallon, per passenger, etc.).
Examples (federal-level figures):
– Small cigarettes: $1.01 per pack of 20
– Pipe tobacco: $2.83 per pound
– Beer: $3.50 for the first 60,000 barrels (federal rate, varies by production)
– Cruise ship passengers: $3 per passenger
– Gasoline: $0.183 per gallon (federal gasoline excise)
Multiple layers: Federal and state governments can both tax the same product. For example, a state cigarette tax of $5.35 per 20-pack plus the $1.01 federal tax results in $6.36 in excise taxes per pack before retail markup.

Excise taxes on retirement accounts

Certain tax penalties related to retirement accounts are treated as excise taxes:
* Excess IRA contributions not corrected by the deadline: 6% excise tax per year on the excess amount.
Early distributions from IRAs or qualified plans before age 59½: typically a 10% excise tax penalty (subject to exceptions).
Missed required minimum distributions (RMDs): a 25% excise tax on the amount not withdrawn, reduced to 10% if corrected within the IRS correction window. The correction window begins when the penalty is imposed (often January 1 following the missed distribution) and ends at the earlier of the IRS assessment, an IRS notice of deficiency, or the last day of the second taxable year after the penalty was imposed. Note: RMD ages changed under recent law; RMDs are required beginning at age 73 for many accounts.

Who ultimately pays?

Although laws typically require businesses to remit excise taxes, those businesses commonly pass the cost to consumers through higher prices. In some cases (for example, certain retirement-account penalties), individuals pay the excise tax directly.

Federal excise tax vs. sales tax

• Excise tax: Levied on specific goods, services, or transactions. It may be ad valorem or specific and is often paid by the merchant but passed on to the consumer.
• Sales tax: A percentage charged at the point of sale on a broad range of goods and services, collected from consumers and remitted by merchants to the taxing authority.

Bottom line

Excise taxes are targeted levies on selected goods, services, or actions. They can be structured as percentage-based (ad valorem) or fixed-per-unit (specific) charges. While merchants generally remit these taxes, the economic burden typically falls on consumers through higher prices. Some excise taxes also function as penalties within the tax code (notably for certain retirement-account issues).