What is excise tax?
Federal excise tax definition, types and examples
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 have excess contributions to your IRA, a 6% excise tax will be applied on the excess amount for each year in which you fail to correct,” said Dr. Lei Han, CPA, associate professor of accounting at Niagara University. “Early distributions from your IRA or retirement accounts before age 59 1/2 are subject to 10% additional tax unless exceptions apply.”
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.
» MORE: How to file back taxes
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.
» MORE: How to file your taxes for free
FAQ
How is an excise tax different from a sales tax?
Excise taxes are often applied to goods and services that are harmful to health or the environment. Sales taxes are applied to a variety of purchases. Additionally, excise taxes are paid by the retailer or producer of the item, while sales taxes are added to the customer’s purchase price.
Who pays excise tax?
Retailers or manufacturers of goods subject to an excise tax will pay that cost. If you’re required to pay an excise tax on your property or IRA, you will pay that cost directly.
How much is excise tax?
This depends on the type of product. Ad valorem excise taxes tend to be between 1% and 10%. Specific excise taxes range from a few cents to several dollars or more. Excise tax may be applied as a percentage of the product’s value or a fixed cost.
What goods are subject to excise tax?
Goods that are harmful to the purchaser’s health or the environment are typically subject to this tax. This includes alcohol, cigarettes and gasoline.
Is there a difference between federal and state excise taxes?
The federal, state and local governments may all charge different excise taxes on products. The funds from this tax may flow to different sources, but that is the only difference between them.
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.
- Article sources
- ConsumerAffairs writers primarily rely on government data, industry experts and original research from other reputable publications to inform their work. Specific sources for this article include:
- Washington State Department of Revenue, "Real estate excise tax.” Accessed Feb. 14, 2023.
- IRS, “An overview of excise tax.” Accessed Feb. 14, 2023.
- IRS, “Publication 590-A (2021), Contributions to Individual Retirement Arrangements (IRAs).” Accessed Feb. 14, 2023.
- U.S. Energy Information Administration, “How much tax do we pay on a gallon of gasoline and on a gallon of diesel fuel?” Accessed Feb. 14, 2023.
- Alcohol and Tobacco Tax and Trade Bureau, “Tax Rates.” Accessed Feb. 14, 2023.
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