What It Is, How It Works, Examples

Excise taxes: The tax levied on certain goods, services, and activities

One of the most common excise taxes consumers pay indirectly is on gasoline. krisanapong detraphiphat/Getty

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• Excise taxes were created to offset costs created by certain goods or services, or to discourage certain activities.
• Retirement accounts can be subject to excise taxes if you save too much, withdraw money early, or don't start taking distributions by age 70 ½.
• Understanding the rules can help you plan right for retirement, maximizing your return from your long-term savings.
• See Personal Finance Insider's picks for the best tax software »

An excise tax is an indirect toll placed on goods, services, or activities as a way to either offset the cost of public usage, or discourage use of certain items. In most situations, you may never directly pay excise tax. Instead, the tax is usually collected directly from the producers or retailers, with the costs of the excise included in the final consumer price. 

For those who plan to draw from their retirement accounts, excise tax could have an impact on how much you invest in, or how much you take out from minimum required distributions. Here's how excise tax could affect how you manage your retirement funds. 

How the excise tax works 

At a high level, excise taxes can be broken down into two categories: penalty taxes and non-penalty taxes. How an excise tax is managed depends on the products and their intended use. 

"Excise taxes are taxes on specific items and usually are on the quantity of an item, rather than its value, as it would be in a sales tax situation," says Kevin Matthews, CPA and tax professor at George Mason University's School of business.

Note: In many situations, the cost of excise taxes are included in your payment. With gasoline and airline tickets, the excise tax is added to the price, meaning you are paying for the company's tax requirement.

One of the most common excise taxes consumers pay indirectly is on gasoline. Every time a consumer fills up, a federal excise tax of 18.4 cents is applied to each gallon of fuel, along with a state excise tax averaging around 32 cents. These taxes pay for highway maintenance, including repairing current roads, and building new ones as needed. 

Another common excise tax is on "sin items," such as cigarettes. The tax varies from state to state: While smokers in the historically tobacco-producing states of Georgia and North Carolina only pay an excise tax of up to 50 cents per pack, those in California, Illinois or Pennsylvania pay up to an additional $3.99 per pack. These taxes pay for tobacco control programs and public health programs. 

Other common excise taxes include: 

• Airport and airways excise tax: On all airline tickets, the government charges a 7.5% excise tax, along with additional taxes for segments, international departures, international arrivals, and a tax on airlines to issue frequent flyer miles through third parties. These taxes pay for homeland security facilities, environmental protection programs, and maintaining airports. 

• Affordable Care Act excise taxes: To help pay for subsidies through the Affordable Care Act, the federal government charges certain excise taxes including on the operators of tanning beds. Operators of indoor UV tanning beds pay a 10% excise tax.

• Alcohol purchases: Both federal and state authorities charge alcohol producers an excise tax based on what they are producing and how much is being produced. In 2019, alcohol accounted for around 10% of federal excise tax revenue. 

• Cannabis purchases: In states where recreational marijuana is legalized, states will charge an excise taxon the commodity. The excise taxes range from 10% in Rhode Island, to 37% in Washington. 

• Coal production: In an effort to help coal miners affected by pneumoconiosis, commonly known as black lung disease, the IRS charges excise taxes on coal mining. Underground mining operations pay the lesser of $1.10 per ton or 4.4% of the sales price, while surface mining companies pay the lesser of 55 cents per ton or 4.4% of the sales price. 

• Sports wagering: While sports wagering is becoming more prevalent across the United States, sports books must pay an excise tax on their income. In states where sports betting is legal, companies must pay a 0.25% tax on each wager, along with a $50 annual occupational tax for each owner or agent accepting bets. 

Excise taxes and retirement accounts 

In addition to charging an excise fee on the most used commodities, taxes can also be applied to your retirement account. How much you could face depends on what you are withdrawing from and when you plan to take the money. 

Quick tip: As you make a plan to save for retirement, sit down with your financial planner to determine how much you should be saving each year. While there's no minimum savings requirement, putting too much away each year could result in paying high taxes on the excessive contribution, which could harm your retirement plans.

On distributions from 401(k) or 403(b) retirement plans, individuals face a 10% excise tax on anything they withdraw before they reach age 59 ½. The additional payment must be reported every year at tax time, and could add to your total tax bill. Exceptions to this rule include payments made from a qualifying retirement account to a survivor once you die, payments made to satisfy an IRS levy, or a withdrawal of up to $5,000 due to a qualified birth or adoption distribution. 

Excise taxes aren't limited to money taken out of a retirement account. If you contribute too much to an individual retirement arrangement (IRA) in a tax year, you could pay an 6% excise tax on that amount (through 2022, the maximum contribution to both traditional and Roth IRAs is $6,000, or $7,000 for those 50 and older). On employer-sponsored plans — like the 401(k), 403(b), or SIMPLE IRA — the excise tax on contributions over the maximum is 10%. To avoid paying the tax, individuals must withdraw the excess and any earnings by the extended due date for that year's income tax return. 

Finally, if you wait too long to draw from your retirement account, you could face a significant excise tax. Under federal law, individuals must start making a required minimum distribution from their retirement accounts once they turn 70 ½. If you do not start drawing from your account by that age, you could face a 50% excise tax on the amount you were supposed to take that year. 

"For retirement plans and traditional IRAs, participants should make sure they take their minimum required distributions," says Jason Loden, tax partner at Baker Botts. "IRA owners and sponsors of retirement plans should also avoid making excess contributions." 

Important dates related to excise taxes 

Although excise taxes have been levied throughout the history of the US, using them as a method to pay for the public trust or discourage activities is a more modern act. To help the country recover during the Great Depression, states approved the 21st Amendment, repealing prohibition and allowing legal alcohol sales once more. To fund government work projects and bring more Americans back to work, Congress implemented an excise tax on alcohol in 1934 of around $2.60 per gallon of spirits. Since then, the excise taxes have increased on both a federal and state level. 

In some cases, excise taxes have been used to protect the environment and hold companies accountable for preventable accidents. The Taxpayer Certainty and Disaster Relief Act of 2020 instituted an oil spill liability tax starting in 2021 and extending through 2025. Oil producers must pay $0.09 per barrel of crude oil received at a US refinery, and on certain petroleum products imported into the country. 

Other excise taxes are implemented to address new vices as they are invented. Once the US Supreme Court struck down the Professional and Amateur Sports Protection Act, the government allowed states to decide whether or not they would allow sports betting. The ruling also opened the doors for excise taxes. In states where betting is legal, sports books must pay a tax of 0.25% of each wager and a flat occupational tax for each agent taking bets. In states where it is not yet legal, those same companies must pay 2% excise taxes on accepted wagers and an increased occupational tax.

The bottom line

Although consumers don't often pay for excise taxes, understanding what they are and how they work when it comes to retirement can help them make an effective plan. Through working with financial professionals and regular auditing of savings plans, individuals can make sure they are on the right path toward retirement. 

"People should work with their financial advisors and tax accountants — preferably CPAs, estate attorneys or tax attorneys — to know about these taxes and what to do to avoid them, if they are penalty taxes," says Matthews. "With regards to taxes on plans, this is a part of the process of the auditing of the pension plan, so it requires that you have an expert in auditing these plans working for the benefit of the plan's participants interests."