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The Roles Played in Tobacco Taxation

The Kentucky CPA Journal / Issue 2 2010

Tax in the Bluegrass

June 2010

That the United States federal government, all 50 states and even some localities impose substantial taxes on cigarettes and other tobacco products states the obvious. Since long before the American Revolution, tobacco taxes have been a fiscal mainstay, generating significant tax revenue for governments to use. Today, tobacco products are some of the most highly taxed packaged goods in the United States - bearing an additional tax at each stage of the supply chain. 

Tax ‘em if you got ‘em 
Smoking is controversial, but we probably all know someone who smokes or used to smoke cigarettes. Maybe you smoke? Maybe one of your co-workers smokes - on break, in front of the building? 

Some people roll their own cigarettes, using “roll-your-own” tobacco and cigarette papers or empty tubes. But, Americans do not smoke just cigarettes. Some are aficionados of cigars - perhaps, you enjoy an occasional cigar at a friendly card game or on a backyard deck in the summer. Others put tobacco in a pipe and smoke it, like Sherlock Holmes. 

Americans also use smokeless tobacco. Major League Baseball players used to quite openly chew tobacco and “dip” moist snuff when they played; this controversial practice continues, though many have substituted gum for tobacco. 

All of these types of tobacco are taxed in one form or another. 

Funding health programs with tobacco taxes 

Tobacco tax revenue often funds government-funded health programs in addition to the general operations of government. Federal Legislation enacted in 2009 increased the funding for children’s health insurance provided by the State Children’s Health Insurance Program (SCHIP) by roughly $30 billion and paid for it by way of hefty increases in federal cigarette and other tobacco products taxes. States also use tobacco taxes to fund health-related expenditures. For example, Kentucky helps fund cancer research with cigarette taxes. And, Indiana increased its cigarette tax in 2007 to fund the Indiana Check-Up Plan which provides improved access to health insurance to Hoosiers. Other examples exist across the country. 

Chain taxing tobacco 

Cigarettes and other tobacco products are taxed at each of the three stages in their business cycle, manufacture, distribution and retail sale. The federal government takes the first tax bite on the manufacture of tobacco, and the states and localities take the second and third - imposing tobacco tax collection obligations on tobacco distributors and sales tax collection obligations on retailers. 

TTB and the tobacco factory 

The Alcohol and Tobacco Tax and Trade Bureau - Tobacco Tax Bureau or TTB - administers the federal tobacco tax laws and collects federal tobacco taxes. TTB is small, having approximately 600 employees, particularly when compared with the Internal Revenue Service which has over 85,000. Every cigarette and tobacco manufacturing plant must have a tax permit issued by the TTB, and the manufacturer pays federal excise tax to TTB on cigarettes and tobacco products removed from the plant. 

As there are many different types of tobacco products, there are many different tax rates. For example, “small” cigarettes are taxed at $1.01 per pack of 20 cigarettes. A “small” cigarette is the traditional cigarette with which most people are familiar. Small cigars are likewise taxed at a rate of $1.01 per pack of 20, whereas large cigars are taxed at 52.75 percent of the manufacturer’s sale price with a maximum of $0.4026 cents per cigar. Roll-your-own tobacco is taxed at $24.78 per pound as a result of the 2009 SCHIP legislation. To make a pack of 20 cigarettes, approximately ¾ oz. of roll-your-own tobacco is needed. This equates to a tax of approximately $1.16 per pack - more than pre-made cigarettes. So, why roll your own when you can purchase a pre-made cigarette? The answer is that the federal government for years did not tax roll-your-own tobacco. 

The predominant method of computing tax is per unit (small cigarettes and small cigars) or by weight [roll-your-own, pipe tobacco, chewing tobacco, and snuff are taxed at per pound tax rates]. The ad valorem, i.e., by value, method is used only for large cigars. 

Wholesale taxation 

Distributors of cigarettes and other tobacco products must be licensed by the applicable state department of revenue, although the nomenclature can vary. For example, Kentucky refers to some of its licensees as wholesalers. A licensed distributor’s operations must conform to requirements mandated by state law, which can be complex - especially when the distributor operates in multiple states. 

Every state imposes an excise tax on the sale or consumption of cigarettes, typically paid by a distributor via a tax stamp affixed to each pack of cigarettes. To determine if state excise tax has been paid, just pick up the pack and look for a tax stamp. 
Cigarette tax rates range from a low of $0.07 (South Carolina) to a high of $2.75 (New York) per pack, as of Jan. 1, 2010. South Carolina is the only state that currently does not require a tax stamp. Some per pack cigarette tax rates of regional interest include: Kentucky ($0.60); Tennessee ($0.62); Indiana ($0.995) and Ohio ($1.25). Notice that the uniform method of taxing cigarettes is per unit rather than by value. 

In contrast, state excise taxes on other tobacco products are much less uniform but are generally imposed as a percentage of the wholesale price. When taxed, rates range from 5 percent in South Carolina to 92 percent in Vermont. Kentucky taxes most tobacco products at 15 percent of the wholesale price, except for moist snuff which it taxes at a rate of $0.19 per unit (a container of 1.5 oz. of snuff, or less). Unlike cigarette taxes, other tobacco products taxes are generally paid via a tax return - and not with tax stamps. In some states, localities also impose their own tobacco taxes, but not in Kentucky. 

Retail sales taxes 

As with other goods sold at retail, cigarettes and other tobacco products are generally subject to sales tax (state and local, if applicable) when they are sold at a retail store. A sales tax is computed as a percentage (in Kentucky, 6 percent) of the selling price of the goods sold; so, a portion of the sales tax is actually a tax on other taxes. 

Big taxes, big issues 

Higher taxes discourage the use of tobacco. They also incentivize people to attempt to legally avoid or illegally evade these taxes. Consequently, tax administrators and law enforcement agencies must deal with problems like smuggling of black market cigarettes sold without all applicable taxes being paid. New York alone claims to have lost $1 billion in tobacco tax revenue in 2007 on sales of untaxed cigarettes. 

Taxes, taxes and more taxes 

“You’re not up to no good are you? Because if you are there’s a 25-cent up-to-no-good tax.” - The Tax Man in “Popeye” (1980). 

Cigarettes and tobacco products are among the most highly regulated and taxed packaged goods, bearing up to three levels of significant taxes. These products, though controversial, fund not only general government services, but also federal and state health care programs. As such, they are unlikely to disappear in a puff of smoke anytime soon. 

About the author: Mark A Loyd, Esq., CPA, is a member of Greenebaum Doll &McDonald in Louisville and chairs its State and Local Tax Team. He is a member of the KyCPA board of directors; chair of the editorial board; member of the industry task force; and former chair of the taxation committee.



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