Diesel particulate filters: Taxation and credits

By Deborah Gordon, J.D., LL.M., and Taylor Cortright, J.D., LL.M., Washington

Editor: Mary Van Leuven, J.D., LL.M.

Diesel particulate filters (DPFs) are exhaust aftertreatment devices installed on diesel-powered vehicles that are intended to significantly reduce the vehicle's emissions. This discussion focuses on the federal excise tax treatment of DPFs and potential fuel tax credits that may be claimed for fuel used to operate DPFs.

Background

In 2007, the Environmental Protection Agency (EPA) implemented new vehicle-emission standards for diesel-powered vehicles, mandating, among other things, the adoption of specific procedures for exhaust regeneration. To meet these standards, diesel-powered vehicles are now equipped with DPFs. DPFs can cost $5,000 to $15,000.

When installed, DPFs are intended to collect particulate matter, including soot, from exhaust and to oxidize and break down the particles in a manner that reduces harm to the environment. DPFs physically trap and remove particulate matter as part of the exhaust system. The trapped particulate matter accumulates in the DPF and is eventually cleaned from the filter through a process called regeneration. Regeneration occurs when particulate matter combusts in the filter, converting it to ash, carbon dioxide, and water.

In some cases, the regeneration occurs when a small amount of diesel fuel reacts with a catalyst in the DPF to cause the particulates to combust. The diesel fuel is typically injected via a separate fuel supply line into the DPF from the fuel supply tank of the vehicle into the vehicle's exhaust system.

The IRS has issued nonprecedential guidance regarding federal excise taxation of DPFs and off-highway business credits for fuel used in the DPFs. A U.S. district court has also analyzed the issue of taxation of DPFs.

Taxation of DPFs

Sec. 4051 imposes a federal excise tax on the first retail sale of certain heavy vehicles. The tax is generally 12% of the heavy vehicle's sale price. Tax is also imposed on parts or accessories sold on or in connection with the sale of a heavy vehicle.

The issue of whether DPFs are taxable parts or accessories has been raised by truck dealers and other persons liable for this tax. In Notice 2017-5, in defining a "chassis," the IRS noted that it views DPFs to be a component of the chassis and thus subject to the tax. The U.S. District Court for the Northern District of Iowa also reached this conclusion in a refund suit filed by a truck dealer. In Thompson Truck & Trailer, Inc., No. 16-CV-192-LRR (N.D. Iowa 8/7/17), the dealer argued that the DPF was not a taxable part or accessory. The court analyzed the terms "parts or accessories" and held that because the DPFs were component items equipped to the trucks that functioned in relation to the trucks' exhaust systems, they were taxable parts or accessories of the vehicles.

Fuel credits

Generally, federal excise tax applies to diesel fuel that is suitable for use as a fuel in a diesel-powered highway vehicle. The tax imposed on diesel fuel is $0.244 per gallon. Statutory and regulatory exceptions exist for certain nontaxable uses. For example, a credit may be allowable for use of the fuel other than in the propulsion engine of a diesel-powered highway vehicle.

In 2013, in nonprecedential guidance (Chief Counsel Advice 201421017) the IRS concluded that diesel fuel used in certain DPFs was nontaxable because it was used other than as fuel in the propulsion engine of a diesel-powered highway vehicle. In 2017, the IRS supplemented this conclusion in nonprecedential, nontaxpayer-specific advice and concluded that when diesel fuel injected into DPFs during the regeneration process does not enter the combustion chamber of the vehicle's propulsion engine, the diesel fuel is not used in the propulsion engine of the diesel-powered highway vehicle. Therefore, using diesel fuel in this manner is a nontaxable use of the fuel. However, if the diesel fuel used in a DPF enters the combustion chamber of the propulsion engine, then it does not qualify as a nontaxable use (Program Manager Technical Assistance 2018-003).

Observations

DPFs are installed on most diesel-powered vehicles to meet EPA vehicle-emission standards. Persons liable for the excise tax on heavy vehicles should be mindful that the IRS and the U.S. District Court for the Northern District of Iowa view DPFs as taxable parts and accessories for purposes of the tax. However, an excise tax credit may be available with respect to diesel fuel used in the DPF that does not enter the combustion chamber of the propulsion engine.

These articles represent the views of the author(s) only, and do not necessarily represent the views or professional advice of KPMG LLP. The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser. 

EditorNotes

Mary Van Leuven is a director, Washington National Tax, at KPMG LLP in Washington.

For additional information about these items, contact Ms. Van Leuven at 202-533-4750 or mvanleuven@kpmg.com.

Unless otherwise noted, contributors are members of or associated with KPMG LLP.

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