Manufacturers and importers of firearms and ammunition incur liability for excise tax under the Internal Revenue Code (IRC) when they sell or use their products. This article will provide an overview of the articles subject to tax, who is the manufacturer or importer, and exemptions from tax. Part II of this article, to be published in the next edition of Small Arms Review, will address how to determine the taxable sale price, exclusions from the sale price, and tax-free sales.
I. Statutory and Regulatory Background
The manufacturer’s excise tax on firearms, pistols, revolvers, shells and cartridges was first imposed by the Revenue Act of 1918 (codified in the IRC at 26 U.S.C. Subtitle D, Chapter 32 (26 U.S.C. §§ 4181-4219). Implementing regulations are in Title 27 of the Code of Federal Regulations, Part 53. The Internal Revenue Service administered the tax until 1991, when the authority was transferred to the Bureau of Alcohol, Tobacco, Firearms and Explosives (ATF), which was then part of the Treasury Department. ATF administered the tax until the agency was transferred to the Department of Justice in 2003. Consequently, since 2003 the Treasury Department’s Tax and Trade Bureau (TTB) has administered the tax.
26 U.S.C. § 4181 imposes a tax on the sale by the manufacturer, producer, or importer of pistols, revolvers, firearms, shells, and cartridges. The tax is ten percent of the sale price for pistols and revolvers and eleven percent of the sale price for all other firearms and shells and cartridges. The IRC also imposes excise tax on the lease of a taxable article by a manufacturer or importer (26 U.S.C. § 4217) and use of a taxable article by a manufacturer or importer (26 U.S.C. § 4218).
Pursuant to the 1937 Federal Aid in Wildlife Restoration Act (often called the Pittman-Robertson Act), taxes paid into the United States Treasury under Chapter 32 go into a trust fund. The funds may only be used for wildlife restoration and hunter safety training programs.
II. What is a “Firearm” for Purposes of Excise Tax?
For purposes of computing excise tax, it is important to remember that what constitutes a “firearm” is different from how the Gun Control Act defines that term. TTB regulations define “firearms” as “[a]ny portable weapons, such as rifles, carbines, machine guns, shotguns, or fowling pieces, from which a shot, bullet, or other projectile may be discharged by an explosive.”
The term “pistols” is defined, in part, as “small projectile firearms which have a short one-hand stock or butt at an angle to the line of bore and a short barrel or barrels, and which are designed, made, and intended to be aimed and fired from one hand.”
The term “revolvers” is defined as “small projectile firearms of the pistol type, having a breech-loading chambered cylinder so arranged that the cocking of the hammer or movement of the trigger rotates it and brings the next cartridge in line with the barrel for firing.”
Significantly, the definitions of “pistols” and “revolvers” both use the term “firearms.” Accordingly, pistols and revolvers will be subject to tax only if they are “portable” and discharge a projectile by an explosive.
Antique Firearms Are Subject to Excise Tax
The above definition of “firearm” differs in significant respects from the definition of the term in the Gun Control Act of 1968 (GCA). First, antique firearms and their replicas are NOT excluded from the definitions for purposes of excise tax. Muzzle loading firearms (including those that utilize matchlock, flintlock, and percussion cap ignition systems), although not regulated by the GCA, are still taxable articles when sold or used by a manufacturer or importer.
Taxable Firearms Must Be “Portable”
The second notable difference between the GCA and excise tax definitions of “firearm” is the term “portable.” Only “portable” weapons fit within the regulatory definition of “firearm” for purposes of federal excise tax. ATF Rul. 97-2 provides insight on whether particular firearms are “portable” and subject to tax. The ruling addressed certain model 1919 semiautomatic rifles and whether they are “portable” within the meaning of the regulatory definition. ATF held the rifles at issue, which weigh approximately 30 pounds and have an overall length of 53 inches, are portable and subject to tax when sold by the manufacturer or importer. The ruling notes the term “portable” should not be narrowly construed to exclude weapons which cannot be carried on a 20-mile march, which was the test suggested by the manufacturer of the weapon. The ruling makes it clear that even fairly large firearms will be subject to tax if they can be lifted and carried by an average person.
Taxable Firearms Must be Complete
As many readers know, firearms are subject to the GCA even if they are not complete and will not expel a projectile by the action of an explosive. This is because the GCA definition includes frames or receivers and firearms that are readily convertible to fire. Accordingly, if a firearm is missing a firing pin or a bolt, it is still regulated as a “firearm” under the GCA.
This is not the case under the excise tax regulations. In order to be subject to the tax, a firearm must be complete as to all component parts. This concept is demonstrated in ATF Rul. 93-2, which addressed the taxability of a barreled action. The ruling held that a barreled action, which included all parts of a firearm except a stock or grip, is not subject to tax. The ruling makes it clear that the manufacturer’s excise tax applies only to the sale of complete firearms or unassembled firearms sold as kits which are complete as to all component parts.
At this point it is important for us to issue a cautionary note to our readers about the sale of unassembled firearms missing one or more essential component. Manufacturers cannot avoid tax liability by selling a complete firearm in two or more transactions, such as shipping to a purchaser a firearm that is missing one or more components and then subsequently sending the missing parts in a separate shipment. ATF and TTB have consistently imposed tax, plus penalties and interest, on such transactions.
III. What are “Shells and Cartridges?”
The excise tax regulations define “shells and cartridges” as any article consisting of a projectile, explosive, and container that is designed, assembled, and ready for use without further manufacture in firearms, pistols or revolvers. In other words, only completely assembled ammunition (or ammunition kits complete as to all component parts) is taxable, and the ammunition must consist of a projectile, explosive, and container. If any one of the component parts is not present, the article is not complete as to all component parts and would therefore not be taxable.
This definition differs significantly from the GCA definition of “ammunition,” which includes complete rounds of ammunition as well as cartridge cases, primers, bullets, and propellant powder. Because the excise tax definition requires that all three components of the ammunition be present, blank ammunition with no projectile is not subject to tax.
Even if a particular round of ammunition has a projectile, explosive, and container, it will be subject to excise tax only if it is designed, assembled, and ready for use in a “firearm” that is subject to excise tax. If the ammunition is capable of use only in a weapon that does not meet the definition of “firearm,” then the ammunition is not subject to tax.
III. Who is a Manufacturer or Importer?
The regulations define the term “manufacturer” in pertinent part as any person who produces a taxable article from scrap, salvage, or junk material, or from new or raw material, by processing, manipulating, or changing the form of an article or by combining or assembling two or more articles. A manufacturer therefore includes persons who make firearms either from raw materials or by modifying new or used firearms by “changing the form of an article.” The clearest example of manufacture is when someone uses raw materials to produce a pistol, revolver, or other firearm. What is less clear is whether modifications made to existing firearms result in “changing the form of an article” so that manufacturing has occurred. An IRS ruling issued in 1969, Rev. Rul. 69-325, addressed a company that purchased used military-type rifles and converted them to “sport-type” rifles by cutting off the wood stock forward of the rear sight, discarding the upper hand guard, cutting off the end of the barrel and installing a new front sight. The barrel was also cleaned and refinished. The IRS ruled that these modifications resulted in excise tax upon sale of the modified rifle, because the company produced a new and different article.
TTB provides useful information on its website on whether particular modifications made to firearms are “manufacture” that would result in excise tax when the firearm is sold. TTB takes the position that manufacture does not occur if a gunsmith replaces, refinishes, or repairs existing parts of a firearm. TTB also takes the position that checkering grips, engraving, and other types of decorative work generally do not amount to manufacture. However, TTB takes the position that “material alterations” to a firearm that significantly change the function of a firearm amount to manufacture. The agency does not provide examples of alterations that fit within this language. Finally, TTB advises that when “custom” firearms are produced from new or used firearms and the custom firearms are a new and different type of firearm, then manufacture has taken place.
Given the lack of guidance on what appears to be a fairly subjective test, gunsmiths who modify new or used firearms and then sell them may wish to contact TTB for a determination on what may or may not be manufacturing. Lack of knowledge about tax policies generally does not avoid penalties for late or non-payment of excise tax.
Fabricators May Not Be Manufacturers
The regulatory definition of “manufacture” includes language indicating that if the fabricator is provided materials owned by another person, and the owner retains title to those materials, the person for whom the article is manufactured or produced will be considered the manufacturer. There is a great deal of IRS case law on this issue, much of it dealing with modifications to vehicles and taxable articles other than firearms or ammunition. The IRS and reviewing courts focus on whether the fabricator or the party requesting the manufacture/modifications own the raw materials, own the tools and dies, and control production. If you or your company are involved in collaborative manufacturing and are unsure whether you or another party are liable for excise tax on sale of the finished products, contact TTB or qualified counsel for guidance.
In the case of firearms produced from raw materials supplied by consumers, the law and regulations provide an exemption from tax for articles incidentally manufactured for personal use. This is good news for gunsmiths who modify firearms owned by consumers or who produce firearms from frames, receivers, and other parts supplied by consumers. Keep reading this article for more good news about gunsmiths who manufacture no more than 50 firearms per year.
Special Rules for Reloaders
The regulatory definition of “shells and cartridges” makes it clear that a person who reloads used shell or cartridge casings is a manufacturer of shells or cartridges if the reloaded ammunition is sold by the reloader. However, the definition goes on to provide that if a reloader is provided with cartridge cases or shells by a customer and returns the identical casings to the customer, then the customer is the manufacturer. This position is consistent with the fabricator versus vendee rationale outlined above. The definition goes on to state that the customer would be liable for tax only if he or she sells the reloaded cartridges, but the customer’s personal use of the cartridges would be exempt from tax.
The regulatory definition of “importer” provides, in pertinent part, as follows:
Importer. Any person who brings a taxable article into the United States from a source outside the United States, or who withdraws such an article from a customs bonded warehouse for sale or use in the United States. If the nominal importer of a taxable article is not its beneficial owner (for example, the nominal importer is a customs broker engaged by the beneficial owner), the beneficial owner is the “importer” of the article for purposes of chapter 32 of the Code and is liable for tax on his sale or use of the article in the United States.
Determining who the importer is will be simple if there is only one company involved in arranging for shipment to the U.S. and the same company sells the articles. However, if two or more persons are involved in the transaction, determining who the importer is may be just as complex as determining who is the manufacturer. The person who actually secures release of articles from Customs may or may not be the importer for purposes of excise tax.
IRS rulings on importer determinations indicate the agency looks at the realities of who arranges for articles to be imported into the U.S. as the principal, not as an agent. The IRS (and TTB) will consider which of the parties involved in the import transaction assumes the risks typical of an importer and whether the importer of record merely acts as a conduit for transfer of the imported articles to another party. If you or your company are involved in import situations where another party is involved and are unsure which party is liable for excise tax, contact TTB or qualified counsel for guidance.
IV. Exemptions from Tax
The IRC includes the following exemptions from tax:
1. NFA Firearms. Excise tax is not imposed on the sale or use of firearms subject to the National Firearms Act on which the transfer tax has been paid. This makes sense, as the United States should not recover two taxes for the same transaction. Note, however, that the transfer tax must be paid. Tax-free transfers between licensees, tax-free transfers to government agencies, and tax-free transfers of NFA firearms for export do not qualify for the exemption. It may be beneficial for manufacturers and importers to consider whether it is cost-effective to transfer a firearm on a tax-paid basis (via ATF Form 4) and pay the $200 transfer tax so as to avoid excise tax. Depending on the sale price of the firearm, it may save taxpayers money to pay the relatively modest $200 transfer tax rather than a significantly higher 10 or 11 percent excise tax. Qualified special (occupational) taxpayers are legally entitled to transfer firearms on a tax-paid basis.
2. Sales to Department of Defense. No firearms, pistols, revolvers, shells, and cartridges purchased “with funds appropriated for the military department” are subject to tax. Regulations indicate the term “military department” means the Department of the Army, the Department of the Navy, and Department of the Air Force. Regulations further provide that naval aviation and the Marine Corps are included in the Department of the Navy. A separate provision of law in Title 14 of the United States Code provides that no excise tax may be imposed on firearms and ammunition when purchased with funds appropriated for the United States Coast Guard.
TTB regulations make it clear that any manufacturer or importer claiming an exemption from tax based on the military exemption must maintain records establishing their right to the exemption. Purchase orders and government contracts are the best examples of acceptable documentation. Regulations also provide that a statement signed by an authorized officer of the appropriate department will be satisfactory.
Many manufacturers and importers mistakenly believe that sales of firearms and ammunition to all federal agencies are exempt from tax. This is not the case, as only sales to the Department of Defense and the Coast Guard are exempt. Sales to all other federal agencies are taxable transactions. In Part II of this article we will discuss the tax-free sale provisions of Chapter 32, which allow tax-free sales of articles to State and local government agencies (but not federal agencies) if specified requirements are met.
3. Small Manufacturers. An amendment to the IRC effective October 1, 2005, resulted in exempting persons from tax if they manufacture or import less than an aggregate of 50 firearms during a calendar year. The exemption does not apply to shells and cartridges. Information on TTB’s website indicates that once the 51st firearm is manufactured in a particular calendar year, all firearms manufactured that calendar year are subject to tax.
We hope this overview of the firearms and ammunition excise tax rules is helpful to readers, particularly those who are manufacturers and importers. Stay tuned for Part II, in which we address the computation of the taxable sale price, exclusions from the sale price, and tax-free sales.