What is excise tax?

Commonly known as the “sin tax,” the excise tax is a tax on products that are considered harmful or detrimental to public health or well-being, such as tobacco, alcohol and gambling. This tax can also be applied to instances of contributing too much to your independent retirement account (IRA) or is required by some states when you sell or transfer real estate property.

Here is what you need to know about excise taxes and how they affect your finances.

Key insights

• Excise taxes are a type of tax that is levied on specific goods and activities that are considered harmful or undesirable.
• Excise taxes are typically included in the price of the item or service, and are paid by the consumer at the time of purchase.
• Some states may also impose excise taxes on real estate transactions.

Understanding excise tax

An excise tax is a tax levied on specific goods or activities that are deemed harmful to individuals or the environment. Excise taxes are intended to discourage the consumption or use of certain goods and activities, while also generating revenue for the government.

The everyday taxpayer may have to pay excise taxes when they purchase goods or services that are subject to these taxes. For example, when you buy gasoline for your car, a portion of the price you pay includes federal and state excise taxes on gasoline. The same applies to other items like cigarettes, alcohol and airline tickets. In some cases, businesses may be responsible for paying excise taxes, but these costs are often passed on to consumers in the form of higher prices.

It is possible to pay excise taxes in other areas, too. If you contribute over the yearly maximum contribution for your IRA, you can be fined a 6% excise tax per year as long as the excess contributions remain in the account. Additionally, real estate excise tax (REET) is similar and a mandatory tax when you sell or transfer real estate property in certain states.

Types of excise tax

There are two ways excise tax might be charged on goods and services: ad valorem or specific tax.

• Ad valorem: Latin for “according to value,” ad valorem tax is applied as a fixed percentage. In other words, the amount of the tax is determined by the value of the product or service. Property tax is a common example of this.
• Specific: Specific tax is levied per unit sold and based on quantity. For example, a bottle of wine might be taxed at 7 cents per bottle, regardless of its cost.

Even though both types of excise taxes are levied against businesses, the cost is often passed down to consumers. Many business owners increase their prices to compensate for the IRS bill.

Examples of excise tax

Excise taxes are taxes imposed on specific goods and services, rather than on income or property. Here are some common examples of excise taxes:

• Fuel tax: Gasoline and diesel fuel are taxed at both federal and state levels. The tax is usually levied per gallon and is meant to fund highway construction and maintenance. Currently, federal excise tax is 18.3 cents per gallon on gasoline and 24.3 cents per gallon on diesel fuel.
• Firearms and ammunition tax: The current excise tax rate is 10% to 11% of the sales price of firearms and ammunition.
• Cigarettes excise tax: Each pack of cigarettes includes a federal excise tax of around $1 to $2. State and local governments may impose additional taxes on top of the federal excise tax.
• Alcohol excise tax: These taxes vary depending on the type of beverage, its alcohol content and the production capacity of the brewery, winery or distillery.

Note that these taxes are accurate at the time of publication and are subject to change. Taxes also vary by area.

Bottom line

It is good to know what excise tax is, but for the average taxpayer, you don’t have to worry about it too much. Businesses deal with excise taxes, which might be the reason why you see an uptick in cost for some products.

If you own a company that is subject to excise taxes and are worried about your IRS bill, consider contacting a tax relief company.