What is an Excise Tax
An excise tax is an indirect tax on the sale of a particular good or service such as fuel, tobacco and alcohol. Indirect means the tax is not directly paid by an individual consumer — instead, the Internal Revenue Service (IRS) levies the tax on the producer or merchant, who passes it onto the consumer by including it in the product's price.
BREAKING DOWN Excise Tax
Excise taxes are imposed by all levels of government — federal, state and municipal. These taxes fall into one of two categories: ad valorem and specific. Ad valorem excise taxes are fixed percentage rates assessed on particular goods or services. Specific taxes are fixed dollar amounts applied to certain purchases. In some cases, governments levy excise taxes on goods that have a high social cost, such as cigarettes and alcohol, and for this reason, these taxes are sometimes called sin taxes.
An excise tax also refers to penalty taxation for ineligible transactions in retirement accounts.
According to data supplied by the IRS, almost $102 billion was collected in 2016 in excise tax collections.
Ad Valorem Excise Taxes
Ad valorem is a Latin phrase that literally means "according to value." This means the tax varies based on the value of the product or service being taxed. For example, the IRS levies a 10 percent excise tax on indoor tanning services. This means that if a tanning salon charges $100 for a tanning session, it must pay the IRS $10 in excise tax. Similarly, if the company charges $200 for tanning, it must pay a $20 excise tax.
Specific Excise Taxes
Specific excise taxes are a set tax or fee added to a certain product. For example, states and many local governments add specific excise taxes to cigarettes. To illustrate, since 2014, New York State adds a $4.35 tax to each pack of cigarettes, regardless of the base price of the pack. In New York City, the city adds another specific excise tax of $1.50, driving the total tax up to $5.85 for every pack of cigarettes.
This means if one pack of cigarettes costs $2 and another pack costs $4, the first pack costs $7.85, while the second pack costs $9.85. The price with the excise tax included is the advertised price. It is not added on at the cash register as sales taxes are.
Excise Taxes Levied on Retirement Accounts
There are a number of situations in which excises taxes are charged on transactions related to retirement accounts. A 6 percent excise tax applies to excess IRA contributions that are not corrected by the applicable deadline. Similarly, a 10 percent excise tax applies to distributions from an IRA, a qualified plan or a 403(b) account that occur before the participant reaches age 59.5 years of age, and a 50 percent excise tax, referred to as an excess-accumulation penalty, also applies to required minimum distribution amounts not withdrawn by the applicable deadline.