Mindy Tyson Weber, CPA, M.Tax.
The federal excise taxes, tax credits, and exemptions for various types of fuel constitute a terribly confusing area of the tax law, involving several Internal Revenue Code sections and overlapping provisions. This item is intended to provide clarity as to how these various provisions interact and to clear up much of the confusion faced by taxpayers and advisers alike when attempting to claim these tax credits.
The U.S. government imposes excise taxes on a variety of liquid fuels. Along with heavy-vehicle use taxes and truck/trailer sales taxes, these excise taxes are collected by the IRS and placed in the federal Highway Trust Fund. The Highway Trust Fund contains three accounts: a highway account that funds road construction; a mass transit account that funds transit-related projects; and a leaking underground storage tank (LUST) account that, as the name implies, funds the remediation of leakage issues involving underground storage tanks. Once deposited into the Highway Trust Fund, the taxes are distributed to individual states based on a legislatively determined formula.
Since the taxes fund road and transit projects, the transactions subject to fuel excise taxes generally involve fuels used to power trains, cars, boats, and aircraft. When using a fuel for a different purpose, a taxpayer is likely to be exempt from the fuel excise tax. As discussed below, while a taxpayer may use fuel for a “nontaxable use” for excise tax purposes, the same fuel may qualify for federal income tax credits (see discussion of Sec. 6427 below). This is an important point for taxpayers that may erroneously believe they are ineligible for federal credits unless they incur a fuel excise tax liability. While a fuel excise tax obligation may be offset by available federal credits, a fuel excise tax obligation is not a prerequisite to claiming the associated federal income tax credits.
After a fuel leaves a refinery, it can pass through many intermediate channels before reaching the ultimate consumer. However, any gallon of fuel should be taxed only once. If a purchaser pays the excise tax on a fuel and can substantiate that another taxpayer has already paid the excise taxes due, the purchaser may be eligible to submit a claim for refund of fuel excise taxes paid.
This item addresses the fuel excise taxes contained in Secs. 4041 and 4081. The Sec. 4042 tax on fuels used in commercial transportation on inland waterways is outside the scope of this discussion.
Sec. 4041 levies an excise tax on the following fuel types:
- Alternative fuels;
- Compressed natural gas; and
- Fuels used in aviation.
The rate varies between 18.3 cents and 24.3 cents per gallon, depending on the fuel type. In general, Sec. 4041 imposes excise taxes on fuels used for specific purposes, including powering highway vehicles, trains, motor vehicles, motorboats, and aircraft. The person selling the fuel to the owner, lessee, or other operator of the vehicle is responsible for the tax.
Sec. 4081 imposes an excise tax on:
- The removal of a taxable fuel from any refinery or terminal;
- Entry into the United States of any taxable fuel for consumption, use, or warehousing; and
- The sale of a taxable fuel to any person who is not registered under Sec. 4101 unless there was a prior taxable removal or entry of the fuel.
The “taxable fuels” referred to above are gasoline, kerosene, and diesel. The rates of tax are 18.3 cents per gallon for gasoline and 24.3 cents per gallon for kerosene and diesel. When considering a fuel excise tax issue, practitioners should be aware that while both Secs. 4041 and 4081 are fuel excise taxes, they appear in separate chapters of the Code. The Sec. 4041 excise tax is a “retail excise tax” under Chapter 31 of the Code, while the Sec. 4081 tax is a “manufacture excise tax” under Chapter 32. This is significant, as many provisions of the Code apply only to the Code sections contained within the same chapter. While a detailed analysis of this issue is beyond the scope of the current discussion, practitioners should take note when a provision of the Code contains the phrase “under this chapter” or similar limiting language.
Sec. 4081’s reference to Sec. 4101 highlights an important point. Sec. 4101 requires certain taxpayers to register with the IRS by filing Form 637,Application for Registration (for Certain Excise Tax Activities), when they are engaged in activities subject to excise taxes. The penalty for failing to register is $10,000 for the initial failure and $1,000 for each day thereafter. Given the large penalties for failing to register, taxpayers with substantial fuel transactions should take the steps necessary to determine whether they are required to register. Generally, the following “persons” are required to register:
- Enterers (usually the fuel importer);
- Pipeline operators;
- Position holders;
- Terminal operators;
- Vessel operators; and
- Bus and train operators.
A person may, but is not required to, register if the person is a:
- Feedstock user;
- Gasohol blender;
- Industrial user;
- Throughputter that is not a position holder;
- Ultimate vendor; and
- Ultimate vendor (blocked pump, i.e., fuel dispensed in a secure pump).
Paying the Excise Taxes Due
A taxpayer reports its fuel excise tax obligation on Form 720, Quarterly Federal Excise Tax Return. Once a taxpayer submits Form 720 and remits the excise taxes due, it is possible that 100% or more of the excise taxes paid can be refunded to the taxpayer if the fuel is being used for an exempt purpose or qualifies for any of several available fuel tax credits, refunds, or payments.
Form 720: Part I of Form 720 contains a long list of the products subject to federal excise taxes. Twenty-four categories of fuel and transactions involving specific fuel types are subject to federal excise taxes. For example, the following can trigger the excise tax on diesel fuel:
- Removal of diesel at the terminal rack;
- Taxable events other than removal at the terminal rack;
- Sale or removal of biodiesel mixture other than removal at the terminal rack;
- Removal of diesel-water fuel emulsion at the terminal rack or other taxable event; and
- Sale of dyed diesel fuel (LUST tax).
Semimonthly deposits of excise taxes due: After determining its excise tax liability, a taxpayer is generally required to make semimonthly deposits of the taxes via electronic funds transfer (EFT). The taxes for a semimonthly period are due by the 14th day following the semimonthly period. Taxpayers with a net liability for taxes on Form 720, Part 1, of $2,500 or less are not required to make semimonthly deposits. Instead, the taxes are payable with the taxpayer’s federal income tax return.
To ensure timely deposits, the EFT should be initiated at least one day before the deposit is due (before 8 p.m. ET). When it is not possible to initiate the deposit one day before, there is a limited same-day payment option (see the Form 720 instructions). If a deposit due date falls on a nonbusiness day (e.g., weekends and legal holidays), the deposit will be considered on time if it is made by the close of the next business day.
When to file Form 720: Form 720 must be filed for each quarter of the calendar year as follows:
Form 720X: Taxpayers that either neglect to file the necessary Forms 720 or need to amend the forms should file an amended quarterly federal excise tax return using Form 720X, Amended Quarterly Federal Excise Tax Return.
Exemptions, Credits, Refunds, and Payments Associated With Fuel Excise Taxes
There are a variety of exemptions from the excise taxes imposed under Secs. 4041 and 4081, as well as procedures for claiming credits, refunds, and payments related to the taxes.
Nontaxable uses of fuel: As noted previously, fuel excise taxes are imposed on fuel that is used in the nation’s transportation systems. If a fuel is used for another purpose, it may be considered a nontaxable use of the fuel. Taxpayers paying excise taxes on fuels used for nontaxable purposes may claim credits or refunds for any excise taxes paid. The following uses of fuels are considered nontaxable for excise tax purposes (see Table 2-1 of Publication 510, Excise Taxes (Including Fuel Tax Credits and Refunds), or the instructions for Form 720 for a complete list of nontaxable uses):
- Fuels used for off-highway business uses (e.g., fuel used to power a generator for a business);
- Fuels used on a farm for farming purposes (e.g., to power farming equipment);
- Exported fuels;
- Fuels used for intercity, school, and local buses;
- Fuels used by a qualified blood collector organization;
- Fuels used in an aircraft or vehicle owned by an aircraft museum;
- Fuels exclusively for use by a nonprofit educational organization; and
- Fuels exclusively for use by a state, a political subdivision of a state, or the District of Columbia.
Taxpayers should report nontaxable uses of fuel on Schedule C of Form 720.
Credits against fuel excise taxes: Sec. 6426 provides generally that a taxpayer is entitled to a credit against the excise taxes imposed by Secs. 4041 and 4081 for the following fuel types:
- Alcohol fuel mixtures;
- Biodiesel mixtures;
- Alternative fuel mixtures; and
- Alternative fuels.
The credits are allowed only for fuels produced in the United States.
Alcohol fuel mixture credit: Sec. 6426(b) allowed for an alcohol fuel mixture tax credit against Sec. 4081 excise taxes for the removal, entry, or sale of alcohol fuel. “Alcohol” is defined as methanol and ethanol, but it does not include alcohol produced from petroleum, natural gas, or coal or having a proof of less than 190. An “alcohol fuel mixture” is a mixture of alcohol and a taxable fuel (gasoline, diesel, or kerosene) that the taxpayer sells or uses as a fuel. The credit equals 45 cents per gallon of alcohol used (60 cents if the mixture does not contain ethanol). The alcohol fuel mixture credit expired on Dec. 31, 2011, but it is still available for taxpayers with open tax years up to this date.
Biodiesel mixture credit: The biodiesel mixture credit under Sec. 6426(c) is also a tax credit against Sec. 4081 excise taxes. A “biodiesel mixture” means a mixture containing biodiesel and diesel fuel, which the taxpayer sells or uses as a fuel. The amount of the credit is $1 per gallon of biodiesel used in producing a biodiesel mixture.
To claim the biodiesel mixture credit, a taxpayer must obtain a certification statement as provided in Notice 2005-62 from the producer (or reseller) of the biodiesel that identifies the product produced and the percentage of biodiesel and agri-biodiesel in the product. The biodiesel mixture credit expired on Dec. 31, 2013.
Alternative fuel mixture credit: The alternative fuel mixture credit under Sec. 6426(e) completes the trio of fuel mixture excise tax credits. An “alternative fuel mixture” is a mixture of alternative fuel with gasoline, diesel, or kerosene that is sold or used by the taxpayer as a fuel. “Alternative fuels” consist of the following:
- Liquefied petroleum gas (propane);
- P Series Fuels (renewable nonpetroleum-based fuels);
- Compressed or liquefied natural gas;
- Liquefied hydrogen;
- Any liquid fuel that meets the carbon capture requirements of Sec. 6426(d)(4) and that is derived from coal through the Fischer-Tropsch process (which converts a mixture of hydrogen and carbon monoxide into liquid fuel);
- Compressed or liquefied gas derived from biomass; and
- Liquefied fuel derived from biomass.
Alternative fuels do not include ethanol, methanol, biodiesel, or any fuel (including lignin, wood residues, or spent pulping liquors) derived from the production of paper or pulp.
The credit is 50 cents per gallon of alternative fuel sold or used in a taxpayer’s trade or business. Unlike the alcohol fuel mixture and biodiesel mixture credits, a taxpayer must be registered with the IRS as an alternative fueler under Sec. 4101 (using Form 637) to claim this credit. The alternative fuel mixture credit expired on Dec. 31, 2013 (Sept. 30, 2014, in the case of any sale or use involving liquefied hydrogen).
In April 2013, the IRS issued a Chief Counsel Memorandum (PMTA-2013-06) in which it concluded the alternative fuel mixture credit can be used only if a taxpayer has a Sec. 4081 liability in the same quarter it sold or used the alternative fuel mixture. For example, assume a taxpayer incurred a Sec. 4081 liability of $25,000 in Q1. In Q2, the taxpayer used 100,000 gallons of alternative fuel to produce an alternative fuel mixture and sold it for use as a fuel. The potential alternative fuel mixture credit would be $50,000 (100,000 gallons × 50 cents). However, the taxpayer did not incur a Sec. 4081 liability during Q2. In Q3, the taxpayer incurred $25,000 of Sec. 4081 liability but did not produce or sell any alternative fuel mixture during the quarter.
In this scenario, the taxpayer would be unable to use any of the alternative fuel mixture credit that it generated in Q2 because it did not incur a Sec. 4081 liability during the same quarter. With no carryforward provisions, the taxpayer in this example would completely lose its alternative fuel mixture credit. For this reason, taxpayers should attempt to ensure they incur a Sec. 4081 liability in a quarter in which they perform activities eligible for the alternative fuel mixture credit.
For alternative fuel mixtures produced after Dec. 31, 2011, the alternative fuel mixture credit can be claimed only to the extent of the taxpayer’s excise tax liability. It is no longer possible to claim any excess alternative fuel mixture credit as a payment (as discussed below). This step was taken after the Senate Finance Committee received notice from the IRS that several taxpayers were making large and questionable claims for payment.
The alternative fuel credit: Representing the only Sec. 6426 credit that does not involve some type of fuel mixture, the alternative fuel credit offsets a taxpayer’s Sec. 4041 excise tax liability for the sale or use of alternative fuels, as previously defined above. The taxpayer must sell or use the alternative fuel as fuel in motor vehicles, motorboats, or aviation to claim the credit. The credit is 50 cents per gallon of alternative fuel sold or used and, similar to the alternative fuel mixture credit, requires the taxpayer to be registered with the IRS as an alternative fueler. The alternative fuel credit expired on Dec. 31, 2013 (Sept. 30, 2014, in the case of any sale or use involving liquefied hydrogen).
Payments for Excess Credits
Applying the fuel excise tax credits described above may result in the amount of the tax credit actually exceeding the amount of the excise taxes originally paid. For example, liquefied petroleum gas (i.e., propane) is taxed as an alternative fuel under Sec. 4041(a)(2) at 18.3 cents per gallon. If a taxpayer sells or uses 10,000 gallons of propane in its trade or business during the calendar quarter, it could be subject to federal excise taxes of up to $1,830 on the propane.
However, Sec. 6426(d) provides a 50-cents-per-gallon alternative fuel excise tax credit against the excise taxes imposed by Sec. 4041 if the fuel is sold or used to power a motor vehicle or motorboat. Assuming the taxpayer used all 10,000 gallons of propane to power forklifts used in its business, it would appear to be eligible to receive a $5,000 alternative fuel credit for the propane used during the quarter. However, since it had only a $1,830 excise tax liability associated with the propane, it can claim an excise tax credit only up to the amount of its excise tax liability. In this case, the taxpayer should claim a full $1,830 credit against its alternative fuel excise tax liability using Schedule C of Form 720. The question is what becomes of the remaining $3,170 of tax credit associated with the propane the taxpayer used in its business? Depending on the circumstances, a taxpayer can receive either a payment or an income tax credit for the remaining $3,170, under Sec. 6427.
Sec. 6427: Sec. 6427 is a difficult Code section to apply because it contains 16 subsections and several cross-references to other Code sections. In the context of alternative fuels, the general rule contained in Sec. 6427(a) provides that if an excise tax has been imposed on the sale of an alternative fuel and the ultimate purchaser uses the fuel for a nontaxable use, Treasury shall pay to the ultimate purchaser an amount equal to the excise taxes imposed on the sale. Sec. 6427(a) ensures that if a fuel is used for a nontaxable use, the party that paid the excise taxes has a mechanism for receiving a refund of the taxes paid.
Sec. 6427(e) further provides that if a person produces a mixture described in Sec. 6426 or sells or uses an alternative fuel in its trade or business to power a motor vehicle or motorboat, Treasury will pay that person an amount equal to the applicable Sec. 6426 fuel credit. In essence, Sec. 6427(e) ensures that a taxpayer will receive the full benefit of its fuel tax credits, even if the credits exceed the taxpayer’s federal excise tax liability, and even if the taxpayer had no excise tax liability to begin with. As noted previously, however, Sec. 6427(e) does not apply to the alternative fuel mixture credit for periods after Dec. 31, 2011.
Sec. 6427(k) dictates whether a taxpayer can receive a payment or must file for an income tax credit on its annual income tax return. Generally, Sec. 6427(k) provides that the entities eligible to receive payments are those not subject to federal income taxes, namely governmental entities and tax-exempt organizations. With two exceptions, all other entities are required to file a Form 4136, Credit for Federal Tax Paid on Fuels, with their federal income tax returns to claim a federal income tax refund. Exceptions exist for (1) taxpayers with aggregate quarterly fuel excise tax liabilities of at least $750, and (2) claims filed with respect to a fuel mixture or alternative fuel for any period that is not less than one week and for which the claim is $200 or more under Sec. 6427(e)(1) or (e)(2).
In the example above, since the taxpayer had an alternative fuel claim for the period over $200, it could claim the remaining $3,170 on Schedule C of Form 720 or use Schedule 3 of Form 8849, Claim for Refund of Excise Taxes. A taxpayer that does not have an excise tax liability cannot use Form 720 or 8849. Instead, it must use Form 4136 to claim a refundable income tax credit under Sec. 34 (discussed below).
Claims for payment under Sec. 6427(e) must be filed on or before the last day of the first quarter following the earliest quarter of the claimant’s income tax year included in the claim. For example, a calendar-year claimant’s claim for an alternative fuel sold or used during June and July must be filed by Sept. 30 of the same calendar year.
Income tax credits: If a taxpayer is not eligible for, or does not timely file an allowable claim for, payment under Sec. 6427(e) but used the fuel in a way that qualifies for the tax credits contained in Sec. 6426, Sec. 34 allows the claimant to file the claim as a refundable income tax credit. The Sec. 34 credit is the sum of the gasoline farming (Sec. 6420), special use (Sec. 6421), and nontaxable use (Sec. 6427) credits.
To claim a Sec. 34 credit, it is necessary to file Form 4136 as an attachment to the taxpayer’s income tax return. These claims must be made within three years from the date the taxpayer’s income tax return was filed or two years from the time the income tax was paid, whichever is later.
Taxpayers may “elect out” of the Sec. 6426 excise tax credit regime altogether and claim a nonrefundable income tax credit under either Sec. 40 (alcohol) or Sec. 40A (biodiesel and renewable diesel). The disadvantage of taking this approach is that Sec. 87 provides that the credit amounts determined under Secs. 40 and 40A are required to be included in a taxpayer’s gross income for the year in which the credit is determined. This issue was recently addressed in Chief Counsel Advice (CCA) 201342010, which concluded that, for biodiesel blenders that do not opt for the Sec. 40A credit but instead claim Sec. 6426(c) credits and Sec. 6427(e) payments, the credits and payments in excess of a taxpayer’s excise tax liability are not items of gross income for federal income tax purposes.
CCA 201342010 did not address the question of whether taxpayers that either deducted the excise taxes paid as ordinary and necessary business expenses or included the taxes in cost of goods sold were permitted to receive both an income tax benefit for the excise taxes paid and income nonrecognition of the resulting credits and payments received. The IRS attempted to clarify the issue by releasing CCA 201406001, which provides that taxpayers must first offset any Sec. 4041 or 4081 excise tax liability with the excise tax credits contained in Sec. 6426(b), (c), (d), or (e) before taking the expenses into account for income tax purposes. After doing so, to the extent the excise tax credit exceeds the taxpayer’s excise tax liability, the taxpayer can make a claim for payment under Sec. 6427(e) or a refundable income tax credit under Sec. 34. These excess amounts would not be includible in a taxpayer’s gross income.
The IRS’s position in CCA 201406001 is that fuel excise tax credits utilized by a taxpayer otherwise are a deductible excise tax liability. For example, if a taxpayer incurred $100 of excise tax liability under either Sec. 4041 or 4081, the taxpayer could deduct the $100 expense as an ordinary and necessary business expense or include the tax as a cost of goods sold. If the taxpayer claims an $80 excise tax credit associated with the liability under Sec. 6426(a), it would need to reduce, dollar for dollar, the amount that it deducted or included in cost of goods sold. In this case, after applying the $80 excise tax credit against its $100 excise tax liability, the taxpayer would be left with either a $20 ordinary and necessary business expense deduction or $20 in costs of goods sold.
While the aforementioned CCAs do not specifically address the other fuel credits contained in Sec. 6426, the same treatment that applied to biodiesel mixtures should apply to alcohol fuel and alternative fuel mixture credits since those credits operate in the exact same way. Due to the complexity of the rules and in light of the recent guidance, taxpayers that previously included in gross income credits under Sec. 6426 or payments under Sec. 6427(e) should consult their tax advisers to determine whether it may be possible to amend previously filed income tax returns.
Note: If a taxpayer receives a payment under Sec. 6427(e) for a mixture for which the taxpayer could have been allowed a credit under Sec. 6426, the amount of the payment is considered an “excessive amount” for purposes of Sec. 6206. This amount, and any civil penalties imposed by Sec. 6675, can be assessed by the IRS and collected as if they were taxes imposed by Sec. 4081. Similarly, if a taxpayer claims an income tax credit on Form 4136 for a mixture for which it was allowed a credit under Sec. 6426, the income tax rules related to assessing an underpayment of income tax liability apply.
There are many exemptions and credits available for the excise taxes imposed on the varied uses and types of fuels; however, careful attention to detail is necessary to navigate the complexity of several interrelated Code provisions and related administrative guidance in order to pay the minimum amount of excise tax required by law. Moreover, as several of the credits expired at the end of 2013, uncertainty surrounding whether the credits will be extended makes it important to act now to obtain any available tax refunds.
Mindy Tyson Weber is a senior director, Washington National Tax, for McGladrey LLP.
For additional information about these items, contact Ms. Weber at 404-373-9605 or email@example.com.
Unless otherwise noted, contributors are members of or associated with McGladrey LLP.