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Coal Excise Tax
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Audit Techniques Guide

Coal Excise Tax

Chapter 1 - Introduction

BLACK LUNG

The Black Lung Benefits Act of 1977 was enacted by Congress to compensate individuals afflicted with the disease known as pneumoconiosis or "black lung disease." Black lung disease is caused by inhaling coal dust for prolonged periods of time, usually at least 10 years. In the early stages, black lung disease does not cause respiratory impairment. However, impairment eventually occurs and despite avoidance of further exposure, death usually occurs within a few years.

IMPOSITION OF COAL EXCISE TAX

Section 4121 of the Internal Revenue Code imposes an excise tax on domestically produced coal. The tax does not apply to lignite. Lignite is defined in accordance with the standard specifications for classification of coals by rank of the American Society for Testing and Materials (ASTM). The taxes collected on the sales of coal are deposited to the Black Lung Disability Trust Fund to finance payments of black lung benefits to afflicted miners.

Producers of coal in the United States are liable for the tax upon the first sale or use of the coal. The producer is the person who has vested interest in the coal immediately after its severance from the ground without regard to the existence of any contractual arrangements for the sale or other disposition of the coal or the payment of any royalties between the producer and third parties.

The tax is imposed at two rates, depending on whether the coal is from underground (deep) or surface mines. The tax on deep mined coal is the lower of $1.10 a ton or 4.4 percent of the sales price. The tax on surface mined coal is the lower of $.55 a ton or 4.4 percent of the sales price. Therefore, coal will be taxed at the 4.4 percent rate if the selling price is less than $25/ton for deep coal or less than $12.50/ton for surface coal.

Using a Federal Tax Deposit form, the taxpayer should make semi-monthly deposits based on the incurred liability. (Form books can be obtained by calling 1-800-829-1040.) Additionally, excise taxes are reported on the quarterly filed Form 720 (Quarterly Federal Excise Tax Return). The due date of the return is the last day of the month following the end of the quarter.

ISSUE IDENTIFICATION

Examinations of coal producers have identified numerous recurring issues resulting in substantial understatements of coal excise tax liabilities. This guide includes 13 potential audit issues related to the coal excise tax; each section includes a brief explanation, cites the appropriate Code sections and references, and identifies helpful audit techniques.

BACKGROUND INFORMATION

In the appendices you will find a glossary of mining terms and referral to additional resource material on the coal mining industry.

Issue

Is it permissible to reduce the taxable weight of coal by excess moisture and what method should be used by taxpayers in calculating this reduction in taxable weight?

Explanation

In computing the IRC section 4121 tax on coal, the taxpayer is allowed a calculated reduction of the taxable weight of coal for the weight of excess moisture, but only where the taxpayer can demonstrate through competent evidence that there is a reasonable basis for the existence and amount of excess moisture. Excess moisture may be determined by subtracting the equilibrium moisture from the total moisture.

Law

1. J. Taft Coal Co., Plaintiff v. United States of America, Defendant, 605 F.Supp. 366 (N.D. Ala. 1984), aff'd without opinion, 760 F.2d 280 (11^th Cir. 1985).
   The Court allowed a taxpayer to reduce its black lung excise tax by the additional weight of coal sold which resulted from weight of the excess moisture of the coal. The Court interpreted the regulations to exclude weight of the water which is in excess of the inherent moisture of coal, provided that it can be reasonably determined.
2. Revenue Ruling 86-96, 1986-2 C.B. 181.
   For purposes of the tax imposed by section 4121 of the Code, the Internal Revenue Service will follow the Taft Coal Co. decision regarding the moisture content of coal. The Service will allow a calculated reduction of the taxable weight of coal for the weight of excess moisture, but only where the taxpayer can demonstrate through competent evidence that there is a reasonable basis for its determination of the existence and amount of excess moisture.
3. Costain Coal v. US 36 (Fed Cl 38).
   The IRS argued the excess water has no value. The purchaser did not pay for the excess water at the same rate that they paid for coal. The court ruled the IRS was correct in denying the taxpayer a reduction to the sales price due to excess moisture.

Techniques

1. Ask if the taxpayer is reducing coal tonnage for the excess moisture. Generally, a reduction for excess moisture should not be taken when Federal Excise Tax (FET) is based on the selling price of the coal (sales price method, since FET does not change). Refer to the examples below which reflect the exception when sales price approaches thresholds of $25 (deep coal) or $12.50 (surface coal) per ton.
   
   Example 1
   
   Deep coal is sold at $24.75 per ton f.o.b. mine. A total of 100 tons, including excess moisture, was sold. Excess moisture is determined to be 6 tons.
    
   100 tons sold (including excess moisture) - 6 tons excess moisture (water) = 94 tons of coal sold at $2,475 (amount taxpayer will collect)
    
   $2,475 ÷ 94 tons (price per ton recalculated) = $26.33 per ton of coal
    
   Excise tax limited to $1.10 per ton.
    
   94 tons of coal x $1.10 per ton = $103.40
    
   (If the tax had been collected at 4.4 percent on 100 tons, the amount would have been $2,475 x 4.4 percent = $108.90).
    
   We do not, however, as some taxpayers have attempted, allow them to calculate their excise tax based on 94 tons shipped at $24.75 per ton for a rate of $2,326.50 x 4.4 percent = $102.37. The gross sales price of the coal should remain at $2,475.
    
   Example 2
    
   Coal is sold at $22 per ton f.o.b. mine. A total of 100 tons, including excess moisture, is sold. Excess moisture is determined to be 6 tons.
    
   100 tons sold (including excess moisture) - 6 tons excess moisture (water) = 94 tons of coal sold at $2,200.00 (amount taxpayer will collect)
    
   $2,200.00 ÷ 94 tons (price per ton recalculated) = $23.40 per ton of coal
    
   Excise tax at 4.4 percent of $23.40 per ton = $1.03 per ton x 94 tons of coal sold equal total tax of $96.82.
    
   NOTE 1: If no deduction for excess moisture had been allowed, 100 tons would have been taxed at $22 per ton. $22 x 4.4 percent = .968 per ton x 100 tons equals $96.80. The 2 cent difference ($96.82 above and $96.80 here), is due to rounding. The tax is the same as it was with excess moisture deducted.
    
   NOTE 2: Refer to Issue 3 - Sales Price Inclusive of Federal Excise Tax (FET) for sales less than the threshold price.
    
   
2. Have the taxpayer explain the method used in determining the total and inherent moisture.
3. Examine the taxpayer's workpapers for reasonableness and inquire if OSM has examined and/or accepted the method used for moisture calculation.
4. What ASTM testing method was used? Was it ASTM D1412-93? Inspect lab reports and verify calculation in arriving at the average percent of excess moisture applied to total weight.
5. When deemed necessary, insist on chemical analysis, as per ASTM D1412-93.  Tests should be done on the same seams as those claimed for the moisture reduction.
6. If you believe the methods used do not satisfy Rev. Rul. 86-96, the issue may be referred to an engineer.
7. Low rank or wetter coals, often found in the western United States, may require application of a correction factor to the results of the ASTM D1412-93 testing procedure to determine inherent moisture.

Conclusion

Coal sold at a selling price of less than $25/ton (deep mined) or $12.50/ton (surface mined) requires a recalculation of price per ton, when excess moisture is deducted. If the recalculated price is above $25 per ton, there will be a reduction in tax.

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Issue

Who is liable for the coal tax when the miner does not posses an ownership interest under state law?

Explanation

IRC section 4121 imposes a tax on coal sold or used by the producer after March 31, 1978. The producer is defined as the person in whom is vested ownership of the coal under state law immediately after the coal is severed from the ground, without regard to the existence of any contractual agreement for the sale or other disposition of the coal or the payment of any royalties between the producer and third parties. Thus, the owner of the coal and not the contract miner would be liable for the IRC section 4121 tax for coal.

Law

1. Treas. Reg. section 48.4121-1(a)(1).
   IRC section 4121(a) imposes a tax on coal mined at anytime in this country if the coal is sold or used by the producer after March 31, 1978. For purposes of this section, the term "producer" means the person in whom is vested ownership of the coal under state law immediately after the coal is severed from the ground, without regard to the existence of any contractual arrangement for the sale or other disposition of the coal or the payment of any royalties between the producer and third parties.
    
   Example 3
    
   "A", a limited partnership, is the owner of land on which a coal mine is located.  "A" contracts with "XYZ" Company to extract the coal for a set price per ton.  "XYZ" is an independent contractor and has no ownership interest in the coal mined. Under state law, "A" is the owner of the coal immediately after severance. After "XYZ" extracts the coal from the mine, "A" sells the coal. "A" is the producer of the coal and is responsible for the payment of the excise tax.
    
   
2. JoAnn Coal Co., CA-4, 1989-2 U.S.T.C. para. 16,474.
   The Court's ruling that the taxpayer incurred liability for FET as a coal producer when it was determined that it could sell the coal to whomever it wanted and for whatever price it wanted to charge. The Court was not persuaded by agreements or right to terminate, but who had dominion over the coal after it was mined.

Techniques

1. Determine if the taxpayer is a contract miner or uses a contract miner to mine the coal.
2. Review contract mining agreements to determine who owns the coal under state law upon severance from the ground.
3. Federal excise tax liabilities may not be assigned. Treas. Reg. section 48.4121-1 is specific as to the liability of the producer, without regard to the existence of any contractual arrangement for the sale or other disposition of the coal or the payment of any royalties between the producer and third parties.

It is important to note that a contract miner who erroneously pays FET may subsequently file a claim for refund and the IRS may be required to refund the FET since the contract miner was not liable for the original tax paid.

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ISSUE 3 - SALES PRICE INCLUSIVE OF FEDERAL EXCISE TAX

Issue

How do we determine the FET when it is included in the sale price?

Law

Treas. Reg. section 48.4216(a)-2(a)(1).
Taxes imposed by Chapter 32 are not to be included as part of the taxable sale price of an article and no tax is due on the tax so charged. When no separate charge is made as to the tax, it will be presumed that the price charged to the purchaser for the article includes the proper tax, and the proper percentage of such price will be allocated to the tax.

Techniques

1. Be aware that if the taxpayer is using the sales price method, it is presumed the sales price includes FET. Therefore, if you pick up additional tax based on sales price, you should reduce the sale price by the presumed inclusion of FET. See Treas. Reg. section 48.4216(a)-2(a) for sample calculation.
    
   Computation of Sales Price
    
   The Black Lung Benefit Trust excise tax is a manufacturer's tax. As such, it is assumed the tax is included in the sales price of the coal.
    
   Example 4
    
   Underground coal sold for $21.50 per ton:
    
   1. Assume 1,000 tons sold @ $21.50 per ton $21,500
   2. Divide by 104.4 percent (100 percent equals selling price, plus 4.4 percent equals tax) 104.4%
   3. Adjusted sales price (without FET) $20,594
   4. Times tax rate of 4.4 percent 4.4%
   5. Federal Excise Tax due $ 906
    
   Proof: $20,594 + $906 = $21,500 (sales price)

If the taxpayer is filing a claim, a consent is required from the ultimate purchaser of the coal. See Issue 13, Claim for Refund Issue, for discussion.

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ISSUE 4 - PURCHASED COAL

Issue

How is a producer's tax liability for coal calculated when that producer also purchases coal from unrelated producers?

Explanation

This question can be divided into two areas:

1. Taxpayers may purchase raw coal and mix it with their own raw coal. They clean the coal and sell all of it on a clean basis. Taxpayers may not subtract raw coal purchased from clean coal sold to arrive at taxable coal.
    
   However, if taxpayers purchase clean coal and mix it with clean coal, and then sell all the coal on a clean tonnage basis, the total tons sold can be reduced by the clean coal purchased.
    
   Finally, if taxpayers purchase raw coal and mix it with their own clean or raw coal, and then sell the resultant coal, the total coal sold can be reduced by the raw coal purchased.
    
   
2. The purchase of the coal must be between unrelated parties at fair market value. If the coal was purchased from a related company at less than fair market value, then IRC section 4216(b), dealing with constructive sales price, should be used. The general rule, when inter-company sales are not arm's-length transactions, is that the fair market price is held to be the price received by the company that finally sold to an unrelated company. (Inecto. Inc., 37-2 U.S.T.C. para. 9554, 21 F.Supp. 418.)

Law

1. Treas. Reg. section 48.4121-1(a), provides, in part:
    
   Extract
    
   * * Section 4121 imposes a tax on coal mined at anytime in this country if the coal is sold or used by the producer after March 31, 1978 * * *
    
   For purpose of this section, the term "producer" means the person in whom is vested ownership of the coal under state law immediately after the coal is severed from the ground, without regard to the existence of any contracted arrangement for the sale or other disposition of the coal or the payment of any royalties between the producer and third parties.
    
   Example 5
    
   A company is the producer of coal when it is shown that it has ownership under state law and a company, which is an independent contractor, has no ownership of coal and is not responsible for excise tax payments. Refer to Issue 2.
    
   
2. Regulation section 48.4216(b)-1.
   This regulation generally provides that section 4216(b) pertains to those taxes imposed under IRC section 4121 that are based on the price for which an article is sold, and contains the provisions for constructing a tax base other than the actual sale price of the article, under certain defined conditions.
3. Inecto, Inc., 37-2 U.S.T.C. para. 9554, 21 F.Supp. 418.
   When the Court found that sales outside the affiliated group were for much more than the intercompany group sales, the Court ruled that the sales were not at arm's length. The Court findings that the intercompany sales were at less than the fair market value were sustained by evidence.

Discussion

One difficulty in administering the excise tax for "purchased coal" is determining whether there was an arms-length purchase or if the payment for the coal was to a contract miner. Agents should review the actual contract between the purchaser and seller when the nature of transaction (arms-length transactions and/or producer versus contract miner) is an issue. Intercompany or related party purchases and sales should be looked at very carefully if arms-length transactions are a question. If the entity being examined is reducing taxable sales by purchased coal, verify that the entity does, in fact, have purchased coal.

Techniques

1. Inspect coal purchase orders.
2. Inspect vendor invoices for the purchased coal for both the number of tons and the dollar amount paid.
3. Determine how the purchased coal is resold. Is it sold as is or is it blended with the "producers" own coal? If it is blended, is the "producer" properly reducing for purchased coal? The producer must be able to substantiate purchased coal allowances.
4. Third-party contacts may be beneficial (confirmation with the seller of the coal) as to tons purchased and amounts paid.
5. If the taxpayer being examined is both a "producer" and purchaser of coal, the examiner must consider that some purchased coal could be in ending inventory.  Therefore, more produced coal would have been sold, resulting in more FET owed.
6. Is an excess reduction being taken for purchased coal? The taxpayer may not subtract raw coal purchased from clean coal sold if the taxpayer cleans the purchased coal; therefore, examine any reduction for purchased coal.
7. NOTE: Sales between related parties may contain reductions to taxable sales price for commissions and markups. These are specifically not excludable under Treas. Reg. section 48.4121-1(c).
8. Purchased coal may often provide follow-up leads. Ensure that FET was paid by the producer of the purchased coal.

Contact the district and/or regional engineering group for representative market prices of coal.

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Issue 5 – Export Coal

Issue

Is the sale of domestically produced coal, which was in the stream of export when the IRC section 4121 tax would have been imposed, considered a taxable or non-taxable sale?

Explanation

On December 28, 1998 the district court held the Federal Excise Tax imposed by IRC section 4121 to be unconstitutional as it applies to coal in the stream of export.  Ranger Fuel Corporation, et al. v. United States of America 99-1 U.S.T.C. paragraph 70,109.

A significant number of coal companies involved in international coal transactions filed Form 8849 claims to recoup monies they reported and paid per Form 720.   Most of the claims were filed in 1997 – 2001.  Currently, producers exempt export sales from taxable sales.

Law

1. Ranger Fuel Corporation, et al. v. United States of America 99-1 U.S.T.C. paragraph 70,109.
   Ranger Fuel Corporation filed a motion for summary judgment to declare the IRC section 4121 to be unconstitutional as it relates to exported coal.  Ranger Fuel contended the coal excise tax violated Article 1, Section 9, Clause 5 of the US Constitution (export clause).
    
   The Court granted the plaintiff’s summary judgment.
    
   
2. IRS Notice 2000-28, 2000-21 I.R.B. 1116
   The notice provides guidance for making nontaxable sales of coal for export and for obtaining a credit or refund when the tax has been paid on coal for export.
    
   The notice defines the following:
    
   Stream of Export:
   Coal is in the stream of export when sold by the producer if the sale is a step in the exportation of the coal to its ultimate destination in a foreign country.  For example, coal is placed into the stream of export when (1) the coal is loaded on an export vessel and title is transferred from the producer to a foreign purchaser, or (2) the producer sells the coal to an export broker in the United States under terms of a contract showing that the coal is to be shipped to a foreign country.
    
   Proof of Export:
   Exportation may be evidenced by (1) a copy of the export bill of lading issued by the delivering carrier, (2) a certificate signed by the agent or representative or the export carrier showing the actual exportation of the coal, (3) a certificate of landing signed by a customs officer of the foreign country to which the coal is exported, or (4) in the case in which the foreign country has no customs administration, a statement of the foreign consignee showing receipt of the coal.
    
   Sale:
   Sale means an agreement whereby the seller transfer the coal (that is, the title or the substantial incidents of ownership) to the buyer for consideration, which may consist of money, services, or other things.

Techniques

Examination of the Producer:

1. Determine the proper amount of tonnage that was actually exported.
2. Insure short tons and not metric tons were used.
3. Validate the proof of export
4. Insure the coal was in the stream of export per Notice 2000-28 when sold from the producer to the broker.

Examination of the Broker (Form 8849):

1. Insure claims were timely filed.
2. Review the written consent that the person who paid the tax waived their right to claim a refund of the tax.
3. Review statement from producer that paid the tax to the government that provides the quarter and year for which the tax was reported on Form 720, the IRS Number on which the tax was reported, amount of tax paid on the coal and the date the tax was paid.
4. Determine the proper amount of tonnage that was actually exported.
5. Insure short tons and not metric tons were used.
6. Validate proof of export.
7. Insure the coal was in the stream of export per Notice 2000-28 when sold from the producer to the broker.

Insure the requirements of IRC section 6416 have been met.  (See Issue 13 – Claim for Refund

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ISSUE 6 - TRANSPORTATION COSTS IN SALES PRICE

Issue

Should transportation costs be excludable in arriving at the taxable sales price of coal?

Explanation

The taxable sales price of coal includes all transportation costs up to the point of sale.  Transportation costs which may be excludable from sales price are discussed below.

Law

1. IRC section 4216.
   In determining, for the purposes of this chapter, the price for which an article is sold, there shall be included any charge for coverings and containers of whatever nature, and any charge incident to placing the article in condition packed ready for shipment, but there shall be excluded the amount of tax imposed by this chapter, whether or not stated as a separate charge. A transportation, delivery, insurance, installation, or other charge (not required by the foregoing sentence to be included) shall be excluded from the price only if the amount is established to the satisfaction of the Secretary in accordance with the regulations.
2. Treas. Reg. section 48.4216(a)-2(b)(1).
   Charges for transportation, delivery, insurance, installation, and other expenses actually incurred in connection with the delivery of an article to a purchaser pursuant to a bona fide sale shall be excluded from the sale price in computing the tax.

Discussion

Transportation costs incurred by the producer/seller of coal beyond its mine or cleaning plant (if the coal is cleaned before sale) are deductible by the producer if their FET is based upon the sales price method.

Treas. Reg. section 48.4121-1(d)(4) states, in part, for purposes of determining both the amount of coal sold by a producer and the sales price of the coal, the point of sale is f.o.b. mine, or f.o.b. cleaning plant if the producer cleans the coal before selling it.

Example 6

A deep mine coal producer removes coal from a mine, transports it to a cleaning plant and then sells it to a coal broker at a price of $27 per ton, delivered to the broker's business, 25 miles from the producer's cleaning plant.  The shipment is made by an unrelated carrier at an arms-length transaction price of $2.50 per ton.

The producer is allowed to reduce the sales price when calculating the FET by $2.50, and thereby, arrives at a $24.50 per ton sales price. If the producer transports the coal to the purchaser with his own equipment, a deduction for actual hauling costs from the cleaning point to the purchaser's business would be allowable.

Keep in mind that the deduction for transportation costs will only affect excise tax calculations when the deductible transportation cost brings the price per ton to an amount below $25 (for underground mines) or $12.50 per ton (for surface mines), or reduces the sales price per ton that are already below these amounts, to an even lower figure.

Techniques

1. Inspect workpapers detailing how the taxpayer arrived at FET per return.  Deductions for transportation costs should be verified.
2. Verify that the costs paid to an outside carrier were arms-length transactions.
3. If the taxpayer transports his or her own coal, verify that the producer is deducting only the actual hauling costs.

Examiner should consider IRC section 4216 and Treas. Reg. sections 48.4216(a)-2(b)(1),(2),(3) with regard to transportation charges pursuant to a sale.

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ISSUE 7 - FREEZE DRIED ADDITIVE

Issue

Is the cost of adding a freeze-dried additive to coal allowed as a reduction in computing the taxable sales price of coal?

Explanation

Treas. Reg. section 48.4216(a)-2(b)(1) provides that charges excluded by IRC section 4216(a) "include all items of transportation, delivery, insurance, installation and similar expenses incurred after shipment to a customer begins, in response to a customer's order pursuant to a bona fide sale." Thus, if the freeze-dried additive is applied to the coal when it is in the railroad car while being shipped to the customer, the fee would be excludable from selling price; however, if the freeze-dried additive is added to the coal before being loaded into the rail car, the additive fee would not be excludable in computing the taxable selling price of the coal.

Law

1. IRC section 4216.
   In determining, for the purposes of this chapter, the price for which an article is sold, there shall be included any charge for coverings and containers of whatever nature, and any charge incident to placing the article in condition packed ready for shipment.
2. Treas. Reg. section 48.4216(a)-2(b)(1).
   In any event, no charge may be excluded from the sale price unless the conditions set forth in this regulation section are complied.
3. Revenue Ruling 86-16, 1986-1 C.B. 321.
   In computing the taxable sale price of coal for purposes of the tax imposed by section 4121 of the Code, a charge for the application of a freeze dried additive to the coal is includible where the additive is added prior to delivery.

Techniques

1. Inspect workpapers detailing how the taxpayer arrives at FET per return; a deduction for freeze-dried additive should be questioned.

This is only an issue if the sales price method is being used.

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ISSUE 8 - RAW VERSUS CLEAN TONNAGE

Issue

Should the tax imposed by IRC section 4121 be based on raw or clean tonnage sold?

Explanation

The excise tax on coal applies to the full tonnage of raw coal sold by a producer. No reduction is allowed for extraneous materials subsequently removed. The tax applies when a sale is made or when title passes. If the coal is in its raw state when title passes, then the tax is based on raw tons. If the coal has been cleaned before title passes, then the tax is based on clean tons sold.

Law

1. Treas. Reg. section 48.4121-1(d)(4).
   For purposes of determining both the amount of coal sold by a producer and the sales price of the coal, the point of sale is f.o.b. mine, f.o.b. cleaning point if the producer cleans the coal before selling it. This is true even if the producer sells the coal on the basis of a delivered price. Accordingly, f.o.b. mine or cleaning point is the point at which the number of tons sold is to be determined for purposes of applying the applicable tonnage rate, and the point at which the sale price is to be determined for purposes of the tax.
2. Revenue Ruling 79-119, 1979-1 C.B. 350.
   A producer extracts raw coal from mines and sells it to a coal preparation plant operator. Upon arrival at the plant, the raw coal is weighed and then unloaded on a raw coal stockpile that includes raw coal purchased from various mine operators.  The plant operator pays the producer for each long ton (2240 pounds) of coal delivered, separates the extraneous rock and dirt from all of the raw coal, and sells the resulting clean coal to the consumer.
    
   The excise tax on coal applies to the full tonnage of raw coal sold by a producer to a preparation plant operator (who cleans it for resale to consumers) with no reduction for extraneous materials subsequently removed.
    
   
3. Moose Coal Co. v. United States, U.S.T.C. 1992-1, paragraph 70014.
   The Court, upon review of the evidence in this case, found taxpayer was responsible for washing its raw coal, and therefore, the tax should be based upon the clean tonnage. The point of sale was determined to be after the cleaning, even though they delivered only raw coal to the purchaser, because payments the coal company received were based upon the tonnage of clean coal.

Techniques

1. Inspect workpapers detailing how the taxpayer arrives at FET per return.
2. Determine if the taxpayer is selling clean or raw coal.
3. Determine who is cleaning the coal: seller or buyer.
4. Review contracts (purchase, cleaning, sales, etc.) to determine when title passes.

Question the use of reject percentages. Reject percentages are often used as a constant reduction with little or no documentation to substantiate the rejection rate used. Reject percentages represent the amount of waste material removed from raw coal to obtain clean coal.

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ISSUE 9 - MIX OF UNDERGROUND AND SURFACE COAL

Issue

If coal sold is a mixture of underground and surface coal, how is the tax liability under IRC section 4121 determined?

Explanation

Revenue Ruling 80-125 addresses the issue of determining the tax rate for underground and surface coals that are blended (during cleaning) prior to sale.  The ruling holds that the tax is based on the proportion of each type of coal contained in the end product and the selling price of the coal sold is taken into account for purposes of the percentage limitation.

In cases where coal is produced from both underground and surface mines and placed in inventory, it is not appropriate to allocate sales based only on production percentages. The various inventory amounts must be taken into account and sales must be allocated based upon the underground and surface inventories available.

Law

Revenue Ruling 80-125, 1980-1 C.B. 246.
Computation of the excise tax on coal is illustrated from sales by the producer of surface-mined coal and underground-mined coal that are blended together during cleaning. When the proportion of surface and underground coal is determinable, the tax should be based upon a proportion of each type of coal contained in the end product and the selling price of the coal sold. When the proportion is not determinable, the ratio of the original input of surface and underground coal is used to compute the tax.

Discussion

This is a possible excise tax issue if a coal producer is mining both from underground and surface mines. While producing out of both deep and surface mines may not be common for most coal producers, it certainly is not rare. With the excise tax at different rates for underground and surface produced coal, it is important that the producer correctly report sales and/or use from the different mines.

Coal is sometimes mined, taken directly to a stockpile and placed into inventory with subsequent sales being made out of the inventory. In some cases, coal is mined and sold directly without ever being inventoried.

In the first case, it is not appropriate to allocate sales based solely on production percentages. The various inventory amounts must be taken into account and the sales must be allocated based on the inventory of the two classes available for sale (not just production of the two classes).

Most coal companies have detailed records and can verify the original production to establish beginning inventories and any subsequent additions or removals from inventory. In those cases where no beginning inventory can be determined, it is appropriate for the examiner to arrive at the beginning inventory (by class) for each period, by taking the average percentage of coal produced (by class) over a long period of time and applying this percentage to the total beginning inventory; thereby arriving at an inventory amount for a particular class.

Examples 7 and 8 use extreme amounts, but clearly illustrate the problem and the correct inventory method. This issue is much easier if the stockpile was started during the period being examined.

Example 7

Incorrect Method

The above example demonstrates sales on the production percentage alone would result in far too much of the coal sold being classified as surface coal taxed at $.55 per ton rather than as underground coal taxed at $1.10 per ton.

Example 8

Correct Method

These two examples illustrate that by using an incorrect method, the taxpayer could have understated the tax liability on 320,000 tons (480,000 minus 160,000).

Techniques

1. Determine if the taxpayer has both deep and surface coal mines.
2. Determine if the taxpayer is selling both deep and surface coal; determine the method for allocating or tracking sales for each type.
3. Determine inventory method if the taxpayer is stockpiling coal.
4. Determine if sales are specific as to origin or if the are commingled?

Be familiar with Revenue Ruling 80-125 for the proper method of calculating FET when the taxpayer is selling blended coal from both sources.

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ISSUE 10 - RIVERBED DREDGING

Issue

Is coal extracted from a riverbed by dredging operations subject to IRC section 4121 tax on coal?

Explanation

Coal extracted from a riverbed by dredging operations will not be subject to IRC section 4121 when the taxpayer can demonstrate that the coal had been previously taxed. If the taxpayer cannot demonstrate that the coal had been previously taxed, then Code section 4121 is applicable.

Law

1. Treas. Reg. section 48.4121-1(a)(1).
   For purposes of this section, the term "producer" means the person in whom is vested ownership of the coal under state law immediately after the coal is severed from the ground.
2. Revenue Ruling 92-30, 1992-1 C.B. 355.
   Coal extracted from a riverbed by dredging is not subject to the tax imposed by section 4121(a) of the Code to the extent that the taxpayer can demonstrate that such coal has previously been taxed.
3. Revenue Ruling 87-21, 1987-1 C.B. 310.
   Coal extracted from a riverbed by dredging is subject to the tax imposed by section 4121(a) of the Code at the rate imposed on coal from surface mine. (Caution: see modification made by Rev. Rul. 92-30.)
4. Kanawha Dredging and Mineral Co., Ltd, (88-1 U.S.T.C., 16,463).
   The Court ruled that the taxpayer's sale of dredged coal was not subject to the tax imposed by section 4121(a) of the Code. In so ruling, it noted that 95 percent of the dredged coal had been previously taxed. The taxpayer used the testimony of an expert witness to convince the Court that coal in the river was almost exclusively from spillage during transportation.

Techniques

1. Ask the taxpayer if any riverbed coal is being reclaimed or recovered.
2. Inspect mining permits for identification of coal sources.
3. Reconcile coal sales to the taxpayer's workpapers. Check for coal sales which may be excluded or exempted by the taxpayer.
4. Taxpayer must substantiate that FET had previously been paid on any excluded sales of riverbed coal.

Note: Black lung taxes did not commence until March 31, 1978. Therefore, any coal in place prior to 1978 could not have been previously taxed.

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ISSUE 11 - REFUSE PILE COAL

Issue

Is a person who extracts coal from a coal refuse pile subject to IRC section 4121?

Explanation

IRC section 4121(a)(1) and Treas. Reg. section 48.4121-1(a)(1) include, as a producer subject to coal tax, any person who extracts coal from coal waste refuse piles and/or from silt waste products which resulted from the wet washing of coal. Extraction includes reclaiming the coal through further processing. Sales of an unprocessed refuse pile is not "production" however, and hence, not taxable.

Law

1. Treas. Reg. section 48.4121-1(a)(1).
   The term "producer" includes any person who extracts coal from coal waste refuse piles or from the silt waste product which results from the wet washing (or similar processing) of coal. However, the excise tax does not apply to a producer who sells the silt waste product without extracting coal from it.
2. Darrell Davis d/b/a Davis Enterprises and Midwest Coal Corporation of America v. United States, 92-2 U.S.T.C. 70,020; 972 F.2d 869 (7th Cir. 1992)
   The Court found that a company which extracted coal from the silt waste product as a result of the washing of coal was a producer and subject to the coal excise tax.

Techniques

1. Ask the taxpayer if any coal from waste piles are being reclaimed or recovered.
2. Look for waste piles during the inspection of premises.
3. Inspect records for identification of coal sources.
4. Reconcile coal sales to the taxpayer's workpapers. Check for coal sales which may be excluded or exempted by the taxpayer.

Ensure that the taxpayer's extraction methods do not constitute "further processing". If their processing can be classified as reclamation of coal, it would result in the "waste" coal being taxed.

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ISSUE 12 - THERMO-DRYER COAL

Issue

Is coal used by a producer in a thermal-dryer to dry the producer's own coal subject to the IRC section 4121 tax?

Explanation

IRC section 4121 taxes coal producers on coal they mine and sell. Under Treas. Reg. section 48.4121-1(a)(1), the "use" of coal by a producer is a taxable event. Treas. Reg. section 48.4121-(1)-(d)(3) further defines the term "coal used by a producer" to mean use by a producer in other than a "mining process." Pursuant to court decisions, the Service does not consider coal mined by the taxpayer and used in their dryer to dry their own coal, to be coal subject to FET.

Law

1. Mulga Coal Company, Inc. v. United States of America, 825 F.2d 1547 (11^th Cir. 1987).
   The taxpayer was engaged in the underground mining of coal, and washed and dried the coal it sold to utility companies. The court determined that the taxpayer's use of coal in dryer equipment to dry its own coal was "the use" of coal by a producer in the mining process and not subject to the black lung tax. The taxpayer argued that because the drying of coal is a "mining process" for purposes of percentage depletion under IRC section 613(c)(4)(A), the coal used as a fuel to dry its own coal should not be taxed under IRC section 4121.
    
   Mulga Coal Co. Inc. v. United States of America, action on decision, 1994-02 (July 19, 1993).
   IRS will follow conclusion reached in Mulga Coal Co., Inc. Accordingly, coal that is used to provide heat for drying will be excluded from taxation.
    
   
2. Consolidation Coal Company / USX Corporation / U.S. Steel Mining v. United States, Civil Action No. 88-1604/89-1051/90-1890, 880 F. Supp. 405 (W.D. Penn. 1992).
   The Court determined that coal used as a fuel to dry coal that is also produced for sale is "used in a mining process" and therefore, is not subject to Black Lung Benefit Trust tax under IRC section 4121. See Action on Decision, 1994-02, supra.
3. Island Creek Coal Company v. United States, U.S. District Court, Eastern District of Kentucky, Lexington Division, 91-2 U.S.T.C. 70,012, (E.D. Ky. 1991).
   The District Court adopted and applied Mulga Coal and ordered a tax refund to the taxpayers who used coal as a fuel for drying their own coal. See Action on Decision 1994-02, supra.

Techniques

1. Ask the taxpayer if he or she dries his or her own coal or coal owned by others.
2. Ask what fuel is used to dry coal (electric, diesel, coal).
3. If the taxpayer is using coal to fuel his or her dryers, determine if he or she is using his or her own coal. Inspect production records and workpapers to determine if the taxpayer is reducing his or her taxable production by this "dryer coal."
4. Ask if the taxpayer is using his or her own coal to fuel dryers when drying coal other than his or her own. Coal used to dry the coal for others is not exempt from FET.

Although coal used in a dryer may not be subject to FET, the agent should be aware that this same coal should not be included in the taxpayer's calculation for depletion.

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ISSUE 13 - CLAIM FOR REFUND

Issue

Can a producer of coal subject to IRC section 4121 file a claim to recover an overpayment of FET?

Explanation

Coal producers subject to IRC section 4121 can file a claim provided that they comply with IRC section 6416 which requires that they:

1. Have not included the tax in the price of the coal and have not collected the tax from the buyer or
2. Have repaid the amount of the tax to the ultimate purchaser of the article or
3. Have filed with the Secretary a written consent from the ultimate purchaser allowing the coal producer credit or refund of FET previously paid.

Law

1. IRC section 6416(a)(1).
   No credit or refund of any overpayment of tax imposed by Chapter 31 (relating to retail excise taxes) or Chapter 32 (manufacture taxes) shall be allowed or made unless the person who paid the tax established, under Treasury Regulations prescribed by the Secretary that he (A) has not included the tax in the price of the article, with respect to which it was imposed and has not collected the amount of the tax from the person who purchased such article; (B) or having collected the tax they have repaid the amount of the tax to the ultimate purchaser of the article; (C) or in the case of an overpayment, has obtained the written consent of such ultimate vendor to the allowance of the credit or making of the refund.
2. Riviera Manufacturing Co., Inc. v. United States, 307 F.Supp. 916 (D. Colo. 1969), aff'd. 440 F.2d 780 (1971).
   The District Court ruled that the claimant must prove that the excess tax was not passed on to ultimate consumer when making a claim for excess taxes. They cited the need for clear and decisive evidence that the tax has been borne by them and not passed on in the form of manufacturing cost.
3. Gordag Industries, Inc. v. United Sates, 63-2 U.S.T.C. 15,532 (D.Minn. 1963)
   The District Court denied the taxpayer's request for refund citing its failure to establish that tax was not passed on to customers. The taxpayer had not filed written consent nor did they convince the Court that the tax was not included in the price of the object or collected from the purchasers.

Discussion

The Service should not permit claims for refund unless the taxpayer satisfies the requirements of IRC sections 6416(a)(1)(A) through (D). These Code sections state that, in order to receive a refund of retail and manufacturers excise tax, the taxpayer must have born the burden of the tax. For example, an examiner working claims for refunds of black lung excise tax must not only verify that the claim amount is correct, but must also make certain that the taxpayer meets the requirements for refund per IRC section 6416.

Chapter 3 - General Audit Techniques

1. Reconcile Form 720 return to taxpayer's worksheet. If tax is reported under abstracts 37 or 39, ask how tax was calculated to determine if tax was calculated correctly under the manufacturer's excise tax guidelines.
2. If state severance tax returns are required, reconcile the Form 720 to state returns.
3. Reconcile the Form 720 to the Office of Surface Mining (OSM) quarterly returns. Currently, OSM does not exempt export coal sales.
4. The tax is to be calculated on a load-by-load basis. Documentation should be available stating the rate paid for each load delivered to the purchaser; average sales price calculations are not acceptable.
5. Reconcile the monthly sales journal to the sales invoice worksheet. The sales invoice worksheet should be supported by delivery tickets which support the number of tons delivered. A remittance advice should be available which details the loads being paid for by the purchaser.
6. Reconcile weekly production reports to the sales journal. Weekly production reports should show the tonnage reported from each mine.
7. If coal is purchased, and thus not subject to tax because the tax was supposedly paid by the producer, review the canceled checks to support the purchases. Obtain the EIN, name, and address of the company from whom the coal was purchased and review their transcript to ensure that the other company has filed a Form 720.
8. Taxpayers often mine someone else's mineral rights for which royalties are paid. Ask to see mineral right agreements to determine if royalties are payable; how royalties are calculated; and to whom royalties are paid. Some agreements call for a minimum annual payment or a set rate per ton. Royalties per the agreements should be reflected on the income tax return; if not, why not.
9. Ask how many seams are being mined; how many mines are being operated; how many miners employed; how many shifts are run?
10. How is coal transported? Transportation costs to the buyer may be deductible.

Chapter 4 - Sample Information Document Requests (Form 4564)

Following are two samples of information document request.

NON-CEP QUESTIONS

1. Retained copy of Form 720 (for quarter under audit) with supporting workpapers showing how tax was calculated.
2. Copy of your Federal Income Tax return Form 1120S, 1120, 1065, or 1040 for (prior, subsequent, year of Form 720 under examination) for inspection.
3. Copies of Forms 941, 940, W-2, 2290, 8300, and 1099 for periods during (year of Form 720 under examination, to present) available for inspection. Copies of Form W-4 for all employees for the most current year.
4. Retained copies of Forms 720 for period beginning ___(date)___ and ending ___(date)___ for inspection.
5. Copies of OSM, MSHA, and state production reports (for example, Department Environment Resources, severance tax, reclamation returns) for the period ________.
6. Copies of Federal audit reports for prior examinations of your income and/or excise tax returns within the last three (3) years.
7. Copies of audit reports reflecting examinations by OSM and/or state agencies within the last three (3) years.
8. Purchase journals and invoices evidencing all coal purchases during ________.
9. Sales, accounts receivable, cash receipts journals, and general ledger detailing all coal sales during ________.
10. Copies of contract mining agreements, purchase coal agreements and royalty contracts during ________.
11. Information regarding related party sales; for example, related corporations, partnerships, and sole proprietorships.
12. If gross production includes lignite, indicate quantity mined and sold during the audit period. Lignite is not taxable under IRC section 4121.
13. A list of types of off-road and on-road equipment using diesel fuel and/or special motor fuels.
14. Purchase journals and invoices for diesel fuel acquired tax-free, if applicable. Also, records on company use of such fuel.

CEP QUESTIONS

1. Was a Federal Excise Tax Return, Form 720, filed by you or your subsidiaries for any quarterly periods in the last two years? yes/no
2. Was a Claim for Refund of Excise Taxes, Form 8849, filed by you or your subsidiaries for any period in the last two years? yes/no
3. Was a Federal Highway Use Tax Return, Form 2290, filed by you or your subsidiaries for any period in the last two years? yes/no
   
   If the answer to questions 1, 2 or 3 was yes, please provide a copy of all Forms 720, Form 8849 or 2290 filed in the last two years.
   
   
4. Do you or your subsidiaries maintain bulk diesel fuel, fuel oil, or heating oil tanks for any of the following:
   1. Highway type vehicles (trucks, tractors): yes/no
   2. Heating: yes/no
   3. Off-highway equipment (bulldozers etc.): yes/no
   4. River vessels: yes/no
   5. Other: (Please list other equipment) yes/no
5.  
   1. Do you or your subsidiaries have a foreign insurance company (outside the United States) insuring domestic property or life? yes/no
   2. Do you have a captive foreign insurance company? yes/no
6. Do you have any debt obligations from foreign sources?
7. Do you or your subsidiaries either own or lease highway vehicles with a gross vehicle weight of over 55,000 pounds? yes/no
   If yes, please complete the following schedule:
   

   Description of vehicle	Gross Vehicle Weight	Vehicle first put into use
   1990 Mack Tractor*	73,000 lbs.*	March 1990*
   (*example)

    
8. Do you or your subsidiaries import or manufacture any of the following:
   Sports fishing equipment: yes/no
   Electric outboard motors or sonar devices: yes/no
   Bows or arrows: yes/no
   Trucks with a gross vehicle weight over 33,000 lbs.: yes/no
   Trailers with a gross vehicle weight over 26,000 lbs.: yes/no
   Highway Tractors: yes/no
9. Do you or your subsidiaries import products containing or manufactured with Ozone Depleting Chemicals (ODC)? Yes/no
10. Do you or your subsidiaries hold or sell Ozone Depleting Chemicals (ODC) in a trade or business? yes/no
    If yes, please provide quantity of each ODC as of January 1^st for the last two years.
11. Do you or your subsidiaries mine coal or have a contract miner mine coal for you?   yes/no
12. Do you or your subsidiaries operate a vessel on any river in the United States in the last two years? yes/no
13. Do you or your subsidiaries own or operate a railroad or locomotive that runs on rails? yes/no
    If yes, please provide a copy of one invoice from each of your diesel fuel suppliers.
14. Do you or your subsidiaries own/lease or operate a helicopter or an aircraft that has a take-off weight of over 6,000 lbs.? yes/no
15. Do you or your subsidiaries purchase special motor fuels for use in highway motor vehicles? yes/no
16. Have you or your subsidiaries provide any communication service (local telephone service, tool telephone service, or, teletypewriter exchange service) to anyone where you charged a fee?

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