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Frequently Asked Questions about Excise Taxes
In this article, we discuss excise taxes, what they are, how they work, and who pays them. Read on to learn the fundamentals of excise taxes.
What Is an Excise Tax?
According to the IRS, excise taxes are “imposed on various goods, services, and activities.” That definition is vague, so let’s understand exactly what an excise tax is.
Excise taxes are imposed on specific goods or activities to discourage their use. Some everyday items that excise taxes are levied on are:
- Alcoholic beverages
- Insurance premiums
- Amusement activities
From the list of items that incur an excise tax, you may guess that their purpose is to reduce the consumption of items or activities considered to have the potential to cause a negative social impact. For example, cigarettes and sugary sodas can pose a health risk. Excess gasoline consumption leads to more motorists on roadways, which leads to the need for repairs, traffic modulation, etc. In that case, motorists are “paying dues” to use public roads and highways.
These taxes are typically levied at the state and local levels and, in some cases, the federal level.
Two Types of Excise Tax
Excise taxes can fall into one of two categories:
1. Ad Valorem Taxes
Ad valorem is Latin for “according to value.” Fitting with that meaning, ad valorem taxes are assessed based on the determined value of the item being taxed. These taxes are fixed percentage rates levied on particular goods or services such as real estate or personal property. Ad valorem taxes can also include import duty taxes on foreign goods.
2. Specific Taxes
Unlike ad valorem taxes, specific taxes are imposed as a fixed amount applied to certain purchases. These taxes are generally applied to items with a high social cost, such as cigarettes are alcohol. For example, the federal government assesses a $1.01 per pack specific tax on cigarettes. Because of the type of items taxed in this way, specific taxes are sometimes called “sin taxes.”
Now that you understand what excise taxes are and the two types let’s learn more about how they work.
How Excise Taxes Work
Excise taxes are generally levied against businesses. For example, a merchant will pay the wholesaler, then pass that added expense on to the consumer through inflated retail pricing of a product or service. In many cases, consumers never realize they are absorbing the excise tax paid by the merchant.
Excise Tax vs. Sales Tax
Excise taxes are not the same as sales tax. Again, excise taxes are levied against particular goods and services. The responsibility to pay them usually falls on the merchant. Alternatively, sales tax is charged on nearly every item or service and is openly and directly collected by the merchant from the consumer and then passed along to the government. Sales tax is also not a fixed amount but a percentage of the sale price of an item.
Businesses that charge or receive excise taxes must file Form 720 Federal Excise Tax Return quarterly along with quarterly payments. If you have questions about excise taxes, the best way to address this is to have a qualified accountant or CPA explain how excise taxes impact your business.