Federal excise tax traps for the unwary

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

The U.S. government imposes federal excise taxes that can affect a surprising variety of companies. These taxes include the foreign insurance excise tax, the Patient–Centered Outcomes Research Institute (PCORI) fee, and the relatively new stock repurchase excise tax. Compliance with these taxes can be complicated, creating many traps for the unwary. This item discusses recently observed compliance trends to highlight some potential traps and provides suggestions to mitigate penalties and interest.

Introduction: What are excise taxes?

Excise taxes are imposed on a wide variety of sales, uses, activities, and transaction types, potentially spanning across many commodities, services, and industries. The taxpayer can be various parties in the supply chain, such as the manufacturer, the importer, the retailer, or the consumer. Congress periodically amends or adds federal excise taxes to the Internal Revenue Code for a variety of policy reasons. For example, some federal excise taxes fund specific trust funds (e.g., the Highway Trust Fund, Airport & Airway Trust Fund, and Superfund). Other federal excise taxes are so–called sin taxes designed to influence consumer behavior (e.g., excise taxes on alcohol, tobacco, firearms, and wagering). Federal excise taxes are imposed on such a wide variety of activities that a constant awareness and review of developments and a program of active coordination among information owners is needed to avoid accidental noncompliance.

Most federal excise taxes are reported on Form 720, Quarterly Federal Excise Tax Return. Failure to file Form 720; pay federal excise tax timely; and, in some cases, submit deposits of tax on a semimonthly basis can lead to assessment of penalties and interest. Therefore, companies must understand their federal excise tax obligations and establish a process to timely file Form 720 and pay tax.

Form 720 filing, payment, and deposit rules

Form 720 is a quarterly return that is due on the last day of the month following the close of the calendar quarter, subject to special rules for weekends and holidays (Regs. Sec. 40.6071(a)-1(a)). Any liability not already satisfied by a deposit, overpayment, or other type of payment must be paid in full on the return’s due date.

Form 720 is not a consolidated return. Generally, federal excise taxes must be reported on Form 720 on an entity–by–entity basis, even if the entity is disregarded from its owner for income tax purposes (Regs. Secs. 301.7701–2(c)(2)(v)(A) and (B)). In other words, if an entity disregarded from its owner has its own federal employer identification number, it will have its own Form 720 filing obligation. Taxpayers must ensure that the correct entity or entities within the corporate structure are filing Form 720 and remitting excise tax based on the activities occurring in each legal entity. Importantly, Form 720 is a composite return, meaning multiple types of federal excise taxes can be reported on a single form each quarter.

Many federal excise taxes are subject to semimonthly deposit requirements in addition to a quarterly return of tax (Regs. Sec. 40.6302(c)-1(a)). Each semimonthly deposit must equal at least 95% of the taxpayer’s net tax liability for the period, come within a safe harbor, or meet the de minimis exemption (Regs. Secs. 40.6302(c)-1(b) and (e)). Deposits are generally due on the 14th and the 29th of the month for the preceding two–week period, subject to special rules for weekends, holidays, and an extra September payment. They must be made by electronic funds transfer (Regs. Secs. 40.6302(c)-1(c) and (d)), and failure to timely deposit when required may be subject to penalty (Sec. 6656). Failure to timely file or pay may also be subject to penalty (Sec. 6651).

Foreign insurance excise tax

Sec. 4371 generally imposes the foreign insurance excise tax (FIET) on premiums paid to foreign insurers and reinsurers to insure or reinsure U.S. risks. Depending on the type of insurance at issue, the rate of tax is either 1% or 4% of the premium paid (Sec. 4371). The person liable for tax is generally the insured who pays the premium to any nonresident broker, agent, solicitor, or insurer, although the regulations allow the IRS to collect the tax from any of these parties (Regs. Sec. 46.4374–1). In some cases, a broker’s statement will include information about the tax.

Premiums paid to foreign insurers and reinsurers in certain countries may be exempt pursuant to a tax treaty between the United States and the country concerned. In many cases, a foreign insurer will obtain a closing agreement with the IRS to substantiate its exempt status (see Rev. Proc. 2003–78, as amended by Rev. Proc. 2015–46). Premiums paid to foreign insurance companies located in countries that do not have a treaty–based exemption, such as Bermuda, are typically taxable.

The decision around the type of insurance to obtain and the insurer from whom to obtain it is often not made within a company’s tax department, which would normally have federal excise tax responsibilities. Instead, professionals in companies’ treasury, risk, human resources (HR), or other departments may control insurance relationships. Therefore, some due diligence may be required to identify a company’s potential liability for FIET. In addition, FIET is subject to the deposit requirements described earlier, meaning a taxpayer has only about two weeks to make a deposit of tax after a premium is paid. Communication between the procurement team and the tax team is essential to establish a process to meet all FIET deposit, payment, and filing requirements. Any failures to timely deposit, file, or pay may expose the company to penalties and interest.

The following practices may streamline the tax reporting process and limit exposure to penalties and interest:

• Consider whether U.S. risks are covered by a group insurance policy;
• Coordinate within the company to identify the timing and amount of premium payments;
• Classify the type of insurance to ensure the correct rate of tax;
• Consider whether payment to a foreign insurer may be entitled to a treaty benefit and identify whether additional reporting for adopting a treaty-based position is necessary; and
• Review the broker statement and coordinate with the broker, if needed.

Patient-Centered Outcomes Research Institute (PCORI) fee

The PCORI fee is a federal excise tax established to fund the PCORI, an independent, not–for–profit organization that funds and promotes health care research (Secs. 4375 and 4376). Sec. 4376 imposes an excise tax on the average number of covered lives over a plan year for certain self–insured health plans. The regulations provide three methods by which a taxpayer can compute the average number of covered lives for a given plan year (Regs. Sec. 46.4376–1). Although the PCORI fee is reported and paid using Form 720, it is reported annually on the second–quarter return (i.e., the quarter ending June 30, due July 31). The PCORI fee is not subject to the deposit requirements (Regs. Sec. 40.6302(c)-1(e)(1)(iv)).

The information needed to calculate the PCORI fee is often held within a company HR or benefits department. As a result, the responsibility for filing Form 720 may reside outside the tax department, and the responsible professionals may not be trained in or experienced with Form 720, resulting in errors. Any failures to timely file or pay may be subject to penalties and interest.

The following practices may streamline the tax reporting process and limit exposure to penalties and interest:

• Identify internal stakeholders with knowledge of the company health plan;
• Determine a method to compute the average number of covered lives; and
• Develop a standard process to report the PCORI fee on the second-calendar-quarter Form 720.

Stock repurchase excise tax

Sec. 4501 generally imposes an excise tax of 1% of the fair market value (FMV) of any stock of a corporation that is repurchased by the corporation during the tax year, subject to special rules, exemptions, and offsets. IRS guidance provides four methods by which a taxpayer can compute FMV (Prop. Regs. Sec. 58.4501–2(h)). The stock repurchase excise tax is not subject to the deposit requirements (Regs. Sec. 40.0–1). As with the PCORI fee and the FIET, the information needed for compliance with the stock repurchase excise tax resides outside the tax team — in many cases, companies’ finance, accounting, treasury, or HR departments.

The final procedural rules became effective on June 28, 2024, and provided guidance on when, where, and how to file returns for the stock repurchase excise tax (T.D. 10002). A return is required for any covered corporation that makes a repurchase or is treated as making a repurchase pursuant to Sec. 4501. The tax is reported on the Form 720 due for the first full calendar quarter after the end of the covered corporation’s tax year, with an attached Form 7208, Excise Tax on Repurchase of Corporate Stock (a new form) (Regs. Secs. 58.6011–1(a) and (b)). There was a special rule for the very first filing due after promulgation of the final procedural rules. The special rule provided that the filing would be due by the due date of the Form 720 for the first calendar quarter after June 28, 2024, or in other words, it would be filed on the third–quarter Form 720, due on Oct. 31, 2024 (Regs. Sec. 58.6071–1).

The nuance between the period of the stock repurchases being reported (the taxpayer’s income tax year) and the period of the Form 720 quarterly filing (the first full calendar quarter after June 28, 2024) caused confusion for many taxpayers. Many taxpayers mistakenly marked Form 720 with the date of their tax year end rather than the calendar quarter of the Form 720 on which it was reported. This triggered a wave of failure–to–file and failure–to–pay penalty and interest notices. Any taxpayer in this situation had to work with the IRS to reprocess the stock repurchase excise tax return to the correct quarter to reverse the penalties and interest.

The following practices may streamline the tax reporting process and limit exposure to penalties and interest:

• Identify internal stakeholders with knowledge of the company’s stock repurchases, issuances, and other activities that may be relevant;
• Coordinate data collection and assign tasks between internal teams;
• Determine a method to compute FMV; and
• Develop a standard process to report stock repurchase excise tax.

Coming into compliance

If a company discovers that it is in arrears in its federal excise tax obligations for any reason, it will want to get into compliance as soon as possible. Furthermore, it is advisable to get into compliance voluntarily and expeditiously, ideally, before the IRS discovers the issue or opens an audit of Form 720. Generally, the preferred approach is to file the returns and pay the excise tax as soon as the failure to file or pay is discovered. Additionally, companies may consider regularly conducting a self–audit of potential excise tax liabilities and filing obligations to ensure that no items are being inadvertently missed. Excise tax is a complicated area that is always evolving, so it is important to stay educated and up to date.

Editor Notes

Mary Van Leuven, J.D., LL.M., is a director, Washington National Tax, at KPMG LLP in Washington, D.C.

For additional information about these items, contact Van Leuven at mvanleuven@kpmg.com.

Contributors are members of or associated with KPMG LLP.

The information in these articles is not intended to be “written advice concerning one or more federal tax matters” subject to the requirements of Section 10.37(a)(2) of Treasury Department Circular 230. The information contained in these articles 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. The articles represent the views of the authors only and do not necessarily represent the views or professional advice of KPMG LLP.