Diesel fuel used in EPA-required filter exempt from excise tax
TAX ALERT |
The excise taxes related to fuel production and consumption can be a very confusing area for taxpayers to navigate. While there are numerous provisions for the definition and taxation of fuels, many taxpayers may use fuel for a “nontaxable use” for excise tax purposes and thus be able to reduce their excise tax costs. A recent IRS Chief Counsel Advice Memorandum (CCA 201421017) provides guidance regarding a specific nontaxable use of diesel fuel in diesel particulate filters.
Fuel excise taxes and nontaxable uses
Fuel excise taxes in general
The U.S. government imposes excise taxes on a variety of liquid fuels, including diesel. 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: (1) a highway account that funds road construction; (2) a mass transit account that funds transit-related projects; and (3) a leaking underground storage tank (LUST) account that, as the name implies, funds the remediation of leakage attributable to underground storage tanks. Once deposited in the Highway Trust Fund, the taxes are distributed to individual states based on a legislatively determined formula.
Since the above-mentioned taxes fund road and transit projects, the transactions subject to fuel excise taxes generally involve fuels used to power trains, cars, trucks, boats and aircraft. Section 4041 levies an excise tax at the rate of $0.243 per gallon on diesel fuel (in addition to other liquid fuels) that is used as fuel in a diesel-powered highway vehicle. A similar excise tax exists under section 4081 regarding the removal, entry or sale of such taxable fuel and generally applies to refiners and distributors. When considering a fuel excise tax issue, taxpayers should be aware that while both sections 4041 and 4081 are fuel excise taxes, they appear in separate chapters of the Code. The section 4041 excise tax is a retail excise tax under Chapter 31 of the Code, while the section 4081 tax is a manufacturer’s excise tax under Chapter 32. This is significant, as many provisions of the Code use similar definitions and concepts yet only apply to specific chapters of the Code.
Nontaxable use of diesel
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.1 The following uses of fuels are considered nontaxable for excise tax purposes:2
- 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., fuels used 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
- Fuels exclusively for use by a state, a political subdivision of a state, or the District of Columbia
Fuel used in diesel particulate filters
Due to vehicle emission standards enacted by the Environmental Protection Agency (EPA) in 2007, certain exhaust regeneration techniques must be used by operators of diesel vehicles. One such measure is the installation of a diesel particulate filter (DPF), which removes diesel particulate matter, or soot, from the exhaust system of a diesel engine, effectively making the engine emission-free. DPF systems do not add any performance characteristics to the engine and would not be considered an essential part of the engine but for the EPA’s emission standards. Commonly, DPFs burn diesel fuel (separate from the diesel combusted in the engine) to power the regeneration and cleaning process. Due to this fact, the IRS concluded in CCA 201421017 that diesel fuel used in the operation of a DPF on a highway vehicle is used for an off-highway business use and, thus, nontaxable use for excise tax purposes.
Since nearly all diesel-powered highway vehicles are required to meet EPA emission standards, the IRS’ recent guidance is considered a taxpayer-favorable ruling that further differentiates taxable uses of fuel from nontaxable uses. Taxpayers engaged in highway transportation or that own vehicles used on the highway should pay particular attention to this guidance. 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. Taxpayers should consult with their tax advisors to discuss any available excise tax refund opportunities in light of this IRS guidance.
1 See section 6427(I), which discusses fuels used for nontaxable purposes and provides a refund measure for the nontaxable use of diesel fuel.
2 See IRS Publication 510, Excise Taxes (Including Fuel Tax Credits and Refunds), Table 2-1; see also instructions to Form 720 (for a complete list of nontaxable uses).