Part II: Federal and State Tobacco Taxes -- On Fire or Just Smoking?

by Daniel G. Mudd *

In a follow-up to Part I (EIA 7184) ["Basics of Federal and State Tobacco Taxes -- On Fire or Just Smoking?"  by Daniel G. Mudd – Emerging Issues Analysis Commentary], which covered the Federal Excise Tax (FET) considerations for a company involved in the tobacco industry, Part II of this article focuses primarily on the state excise tax side of the business, including state excise/tobacco basics, permits, obligations and reporting requirements, including those mandated by Federal legislation, as well as hot state tobacco tax topics and issues from around the country.

 Basics of Tobacco Products and Types of Businesses for State Excise Tax Purposes

As an initial matter, in addition to evaluating any FET obligations, a business must also analyze and determine any state excise tobacco tax registration, filing, reporting and payment obligations related to the company's tobacco product operations. This analysis becomes even more important for a company seeking to sell or distribute its tobacco products in multiple states, as every state has its own statutory definitions for each type of tobacco product company (e.g., manufacturer, wholesaler, distributor, dealer, retailer, subjobber, etc.), all of which have varying state excise/tobacco tax liabilities and obligations depending on the type of operations the business is involved in, the company's customers (licensees versus consumers), the method of sale or distribution (e.g., online versus standard orders), and the company's location (i.e., resident versus non-resident).

As is true for any business operation, a company involved in the manufacturing, distribution and/or selling of tobacco products in a particular state typically must register with the respective state's department of revenue, as well as apply for and obtain one, or several, licenses/permits to legally operate and/or distribute tobacco products within the state. If a company has multi-state operations, such as a multi-state cigar wholesaler, the company likely must apply for and obtain the proper permit/license for engaging in its resident and non-resident wholesale business. Or, if a company is involved in more than one type of tobacco product operation (e.g., wholesale and retail sales, or manufacture and wholesales), the company typically must obtain the proper permit for each specific operation (and potentially for each location/warehouse the company has within a state). Particular attention must be given to each state's statutory permit/license requirements, as penalties (including criminal in some states) may apply if a company fails to obtain the proper permit or to obtain any permit whatsoever.

Once the proper tobacco product permit(s) is obtained, in order to fully evaluate a company's potential state excise/tobacco tax obligations, if any, one must then determine the specific type of tobacco product being manufactured, imported, sold or otherwise distributed by same, as the tax rate and reporting responsibilities vary greatly for cigarettes, cigars and other tobacco products. For example, most states separately define cigarettes from all other types of tobacco products, but some, like Florida, exclude large cigars from the definition of other tobacco products as it is the only state not to impose a state excise tax on large cigars. [Florida imposes state excise tax on cigarettes, snuff, chewing tobacco, "little cigars" and loose smoking tobacco, but not large cigars. See F.S. §§ 210.25(11), 210.010, 210.02, 210.276. See also, Hi Neighbor Enterprises v. Wynne, [case number unavailable] (Fla Cir Ct 2d Cir 1973) (holding that the amended definition for "cigarettes" was meant to include little cigars, not true/large cigars).] Several non-profit organizations provide basic information online for the various state excise/tobacco tax rates for each state. [See eg, Campaign for Tobacco-Free Kids (providing state by state analysis of tobacco tax rates on cigarettes and other tobacco products), available at http://ltgovernor.ky.gov/taxreform/Documents/20120529_TobaccoFreeKids.pdf.]

In addition to these various state excise/tobacco tax considerations, a company must also be aware of any sales tax on the sale of tobacco products, as many states also impose state (and even local) sales (or business) tax on these products. This means that in addition to applying for and obtaining tobacco tax permits for a company's operations, it may also need to register with each state it sells or distributes tobacco products in for sales tax purposes and obtain a separate sales tax account with the respective department of revenue (assuming sufficient nexus with a state exists). The potential state sales tax obligations for a company depends primarily on the company's customers, as sales to wholesalers typically would not be subject to sales tax (as it would be a sale for resale assuming the proper resale exemption certificate is obtained), while sales directly to individual consumers (through an in-state retail location and potentially through out of-state sales to resident consumers via online sales) would likely be subject to a sales tax – but again, this all depends on the particular state's statutes and regulations. [Although several arguments can be made that the online or remote sales of items (such as large cigars) to consumers in multiple states may not be taxed pursuant to the Federal Commerce Clause under Quill Corp v North Dakota, 504 US 298 (1992), and the Due Process Clause [US Const amend XIV §1], especially after recent cases have strengthened same [see e.g., Goodyear Dunlop Tires Operations, SA v Brown, 131 SCt 2846 (2011); J. McIntyre Machinery, Ltd v. Nicastro, 131 SCt 2780 (2011); Daimler AG v Bauman, Dkt No 11-965 (US Jan 14, 2014); Walden v Fiore, Dkt No 12-574 (US Feb 25, 2014)], such an analysis is outside the scope of this article. But note that a Federal appellate decision recently upheld a plaintiff's Due Process arguments against the PACT Act's mandatory excise tax provisions on the involved internet and mail orders due to a lack of nexus/minimum contacts with certain states. See Red Earth LLC v US, 657 F3d 138 (2d Cir 2011).] Moreover, some states even require that separate legal entities be created in order for a company to sell tobacco products to state licensees, as well as directly to consumers. [See Tennessee Important Notice No. 13-10 (Oct. 1, 2013); Tennessee Important Notice No. 13-07 (Jun. 1, 2013).]

 

* Daniel G. Mudd, Esq., is an Associate and tax attorney resident in the Louisville, Kentucky office of regional law firm Frost Brown Todd, LLC. Daniel's practice focuses on controversy, litigation and planning relating to tax matters, primarily in state and local tax matters and incentives. Through his representation of a number of prominent local and national clients, Daniel has gained experience and expertise in the areas of Federal and state tobacco tax, sales and healthcare-related tax, and energy exemptions. Daniel has also represented a variety of corporate and individual clients in Federal tax controversy and collection matters.

Information referenced herein is provided for educational purposes only. For legal advice applicable to the facts of your particular situation, you should obtain the services of a qualified attorney licensed to practice law in your state.

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RELATED LINKS: For more information on Federal excise tax obligations as they relate to tobacco products, including basic procedure for challenging assessments of FET liabilities, see:

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