Exclusion of State and Local Taxes in
Computing Federal Tax on Large Cigars
Manufacturers and importers of tobacco products:
Purpose. This is to advise you of the enactment of Public Law 90-240
which amends Section 5701(a) of the Internal Revenue Code to provide
for rounding the amount of State and local taxes in computing the tax
on large cigars.
Background. The law presently provides that in determining the retail
price for tax purposes regard shall be had to the ordinary retail price
of a single cigar in its principal market, exclusive of any State or local
taxes imposed on cigars as a commodity. A problem arises under the present
bracket system when State or local cigar taxes are imposed which do not
amount to an even cent. For example, when a State tax amounts to one-half
cent per cigar retailers often round off the retail price of a single cigar
to the next highest cent. This may cause a cigar to be subject to a higher
Federal tax if the retail price of the cigar is at the top of a tax bracket.
Amendment. Public Law 90-240 amends Section 5701(a) of the Internal Revenue
Code by adding after the next to last sentence the following new sentence:
"For purposes of the preceding sentence, the amount of State or local tax
excluded from the retail price shall be the actual tax imposed; except that,
if the combined taxes result in a numerical figure ending in a fraction of a
cent, the amount so excluded shall be rounded to the next highest full cent
unless such rounding would result in a tax lower than the tax which would be
imposed in the absence of State or local taxes."
Effect. The amendment provides, as a general rule, that in determining the
ordinary retail price of a cigar in its principal market the next highest
full cent may be excluded from the retail price when a State or local tax
includes a fractional part of a cent. For example, a cigar which normally
retails for 6 cents is taxed under the Internal Revenue Code at the rate of
$4 per thousand. If a State were to impose a tax of one-half cent per cigar
retailers in that State would normally round this tax to the next higher
full cent and sell the cigar for 7 cents rather than 6 cents each, which
after excluding the State tax of one-half cent would result in a retail
price for Federal tax purposes of 6-1/2 cents. If sales in that State (or
a combination of more than one State imposing such a fractional-cent tax)
resulted in an ordinary retail price in the principal market of 6-1/2 cents
each this would place the cigar in a higher tax bracket of $7 per thousand.
In such a case after the effective date of Public Law 90-240, since the
one-half cent State tax is a fractional part of a cent the amount to be
excluded is rounded to the next highest full cent, thus the cigar would be taxed at the 6 cent rate even though sold at retail for 7 cents each.
The amendment also contains restrictive language to assure that no tax
advantage can be realized by reason of the amended exclusion. A
fractional-cent State or local tax, to be excluded in determining the
price of the cigar for purposes of determining the applicable Federal
tax, is not to be rounded to the next highest full cent for the purpose
of exclusion if this would result in a lower Federal tax than would be
imposed in the absence of the State or local tax. For example, a cigar
sold only in packages of 5 at a retail price of 42 cents (8-2/5 cents
per-cigar) is taxed at the rate of $10 per thousand. If a state tax of
one-half cent per cigar were levied on this cigar and the retail price
for the 5-pack increased to 45 cents (9 cents per cigar) the rule outlined in the preceding paragraph would not be applicable in determining
the Federal tax since the exclusion of the State tax rounded to the
next highest full cent (one-half cent rounded to one cent) would result
in an 8 cents per cigar retail price and a reduction in the Federal tax
to $7 per thousand.
Effective date. Public Law 90-240 applies to removals of cigars
made on and after April 1, 1968.
Revenue Ruling in conflict. Revenue Ruling 67-60 (C.B. 1967-1, 413)
will be modified in respect to the exclusion of State and local taxes
to conform it to the change effected by Public Law 90-240. This
change will be printed in a future issue of the Internal Revenue
Inquiries. Inquiries regarding this circular should refer to its
number and be addressed to the office of your Assistant Regional
Commissioner, Alcohol and Tobacco Tax.
Harold A. Serr
Director, Alcohol and Tobacco Tax Division