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

• 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 70 ½.
• Understanding the rules can help you plan just right for retirement, maximizing your return from your long-term savings.
• This article was reviewed for accuracy and clarity by Lisa Niser, an expert on Personal Finance Insider’s tax review board.
• See Personal Finance Insider’s picks for the best tax software »

Excise taxes are an indirect toll placed on certain 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 on drawing 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 usage. 

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

One of the most common excise taxes consumers pay indirectly is on gasoline. Every time a consumer fills up, a federal excise tax of 18.3 cents is applied to each gallon of fuel, along with a state excise tax averaging around 30.6 cents. These taxes go directly to 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 to prescription drug companies and operators of tanning beds. Operators of indoor UV tanning beds pay a 10% excise tax, while drug companies pay a collective $2.8 billion in excise fees.  

• 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 tax on the commodity. Among the nine states with legal markets, the excise taxes range from 7% in Illinois, to 15% in Colorado and Nevada. 

• Coal production: In an effort to help coal miners affected by Black Lung, 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 $0.55 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 wagering 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. 

On distributions from 401(k) or 403(b) retirement plans, individuals face a 10% excise tax on anything they withdraw before they reach 59 ½ in age. The additional payment must be reported every year at tax time, and could add to your total tax bill. There are certain exceptions to this rule – including 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 Jon Feldhammer, tax partner at Baker Botts and former IRS senior lawyer. “IRA owners and sponsors of retirement plans should also avoid making excess contributions.” 

The financial takeaway

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.”