What Is An Excise Tax And How Does It Work?

What Is An Excise Tax And How Does It Work

The excise tax is a legislative tax on certain goods or services at the time when a customer purchases them. They are taxes that are present within the infrastructure of the government. They are not present on the country’s borders like the international taxes. The government collects these federal excise taxes from airline tickets, motor fuel sales, tobacco, and other goods or services.

While it may seem pretty easy, there is a lot that you need to know in order to understand the federal excise taxes completely. In this article, I will be discussing every single detail about excise taxes and what is related to it.

Key Takeaways

  • The government charges excise taxes only on certain goods or services like tobacco, alcohol, and fuel.
  • They primarily are the taxes that businesses pay, which usually increases the price for the customers indirectly.
  • Excise taxes either be ad valorem, which means you can pay them in percentages. Or be specific, which means the government charges it by units.
  • Sin taxes are a type of excise tax on those goods that have a greater social cost, like tobacco or alcohol.
  • There are certain taxes that customers directly need to pay, like the excise tax penalties and the property tax on specific retirement account activities.

History Of Excise Tax 

History Of Excise Tax

The history of excise tax dates back to the first-ever manufacture of whiskey in the United States back in 1791. However, the tax was not so popular back then, and people served it only till 1802. In the initial years of the Republic, excise taxes were a source of revenue relating to economic downturns and wars.

During the 1934 Great Depression, the revenues through excise tax made up approximately half of the revenue of the federal government. It was also three times more than what the government was then earning through individual income taxes.

At present, federal excise tax imposes itself on tobacco, fuel, and alcohol among every other goods, service, or activity, additionally with a vast range of state excise taxes.

How Does The Excise Tax Work? 

How Does The Excise Tax Work

Excise taxes are mainly for businesses. It is the merchants who pay most of them and then pass the tax over to those customers via a higher price. Merchants pay these excise taxes to wholesalers and include them in their product pricing, which results in an increase in the overall retail price.

As such, the consumers might or might not see the price of most of the excise taxes directly. However, there are certain excise taxes that the consumers directly need to pay, which include property taxes and levies on particular account activities.

Local, state, and the federal government have total authority to institute the taxes. While income tax is the primary level revenue generating tool for the federal and the state governments, excise tax also makes up for a mentionable portion of the total revenue of the government however small it may be.

Excise taxes are mainly business taxes. They are different from every other tax that corporations have to pay, like the income tax. Businesses that charge and receive these excise taxes need to file a Form 720 Federal Excise Tax Return quarterly which may comprise quarterly payments. Professional collectors who are in charge of collecting the excise taxes must maintain these obligations to pass the excise taxes to the local and state governments as per the requirements.

Merchants may also get credits or deductions on their yearly income tax returns depending on these excise tax payments.

Types Of Excise Taxes

There are two main categories in which the federal government divides the federal tax. They are namely:

Ad Valorem Taxes

These excise taxes have a fixed rate of percentage that is assessed on specific goods or services.

Specific Taxes

These are the excise taxes on a fixed dollar amount, which are only applied to specific purchases.

In certain cases, the governments will levy excise taxes on certain goods that have high social costs, like alcohol and cigarettes. These types of excise taxes are sometimes known as sin taxes. This is because this tax carries a reputation of being “sinful” due to the goods that are associated with it.

Ad Valorem Excise Tax 

This is a common Latin phrase meaning “according to value.” The Ad Valorem tax is levied based on a percentage. This causes the excise tax, which depends on the value of the service or the product. For instance, the Internal Revenue Service imposes a 10% excise tax on indoor tanning services. This would mean that if the tanning salon is charging $100 for one session of tanning, it has to pay an excise tax of $10.

Specific Excise Tax 

These are set taxes or an extra fee for a specific product on a per-unit basis. Some of the examples of federal-specific taxes as of October 2023 are small cigarettes, beer, pipe tobacco, gasoline, and cruise ship passengers.

Sin taxes are charged on target products like alcohol and beer. They will usually be taxed on a federal level. Then again, the state will also tax it accordingly. This makes the cost of the items even more high. For instance, New York has a certain excise tax of $4.35 for one cigarette pack of 20. When you combine this with the federal taxes of $1.01, it alone makes the excise tax $5.36. Hence, these taxes create a notable impact on the consumers.

Frequently Asked Questions!! (FAQs)

Q1. Who Pays Excise Duty?

Ans. It is the manufacturer of a good who pays the excise duty, not the consumer. The importer of the goods pays the customs duty. There are quite a few provisions that are common when it comes to paying the customs duty and the excise duty. The major difference here is the place where the production of goods takes place.

Q2. What Is An Example Of An Excise Duty?

Ans. If you are aware of it, you pay taxes on goods, which include cigarettes, soda, alcoholic beverages, insurance premiums, gasoline, betting, and even amusement activities. These taxes make up for a small yet notable amount of the revenue that the government collects. These taxes are examples of excise taxes.

Q3. What Are The Differences?

Ans. The major difference between the excise tax and sales tax is that one has to pay excise taxes on only specific goods and services. On the other hand, sales tax is a concept that includes a wider range of goods and services.

The Bottom Line 

The state and federal governments charge excise tax on selective goods or services. The merchants that sell those goods are the ones who pay the excise tax. Excise tax may just be a flat tax amount or a percentage of the cost of the goods, which is the ad valorem excise tax.

Businesses usually add the cost of the excise tax directly to the price of the taxed goods. Therefore, the tax passes onto the customer. They may or may not be aware of the tax they are paying on top of the original price of the product or service.

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