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Avoid Tax

The big wood-paneled box at Discount Smokes is a tobacco-rolling machine. Into it go loose pipe cigarettes and rolling tubes. With a rattling and grinding of gears, out of it come "smokes" - 190 guaranteed to fill a 200-count box and designed to match the flavor of popular cigarette brands.
The machine also is a number-cruncher. As it whirs and grates inside an East Wisconsin Street building that once housed an H&R Block office, it keeps out the state and federal excise taxes that go along with purchases of manufactured cigarettes.
For a carton purchased in Wisconsin right now, that's an additional $35.21 past the base price: $2.52 per pack for the state and $1.01 per pack for the federal government. Instead of charging $60 or more for a brand-name carton, as convenience stores must, Discount Smokes offers a deal that results in a price of $29.99 a box.
The tax arithmetic at Discount Smokes, owned by Kirk Burnstad, Randy Heinzel and Lon Chester, all of Portage, depends greatly on careful attention to order of operations - but not parentheses, exponents, multiplication, division, addition and subtraction. The key is who does what.
"They manufacture the product. We don't do it," Burnstad said of customers.
"We sell them tubes. We sell them tobacco," Heinzel said.
In mid-April, a first-time customer walked into Discount Smokes, and the owners walked him through the process, starting with picking the brand he wanted to match. Discount Smokes keeps two columned, plastic-covered pages posted on a wall. One column lists popular brands - Salem Full Flavor, Virginia Slim Light and Newport, for example - and other columns list the inputs. For Pall Mall Menthol Ultra Light, that's 2 oz. Blue, 6 oz. Platinum and a menthol tube.
The owners next directed the customer to the tobacco bins and told him to weigh 8 ounces onto a small postal scale. A cassette of rolling tubes went into the machine, the tobacco went into a hopper, and the customer followed directions on a small screen. Every step of the way, the owners demonstrated and directed.
What they pointedly were not doing was any of the work themselves. If they did, the owners said, they'd be manufacturers. Instead, they sell materials and rent the use of the machine to customers in a package deal. Their caution extends to language. For legal reasons, they said, they identify the machine's output as "smokes," not "cigarettes." The containers the "smokes" go into likewise are "boxes," not "cartons."
The machine started and immediately began filling tubes and otherwise processing raw materials. "Smokes" soon spit out of a dispenser, and the customer was packing a box. He said the box would last him a week. At that rate, it would save him about $120 a month in taxes.
How much does the machine cost, the customer asked.
"It's pricey," Chester said.
How many years before you get your investment back?
"Don't know yet," Chester said.
"Well, I'll be letting my friends know," the customer said as he walked out.
Rolling your own
Smokers have long "rolled their own" and avoided excise taxes. The machine at Discount Smokes takes the concept to a new level. It's called an RYO Filling Station and is produced by a company of the same name in Girard, Ohio. RYO claims to have more than 1,000 of the machines in 35 states. At least 43 are within 250 miles of Portage, according to the company website, and the Discount Smokes partners said they know people in Reedsburg and Richland Center who planned to set up RYO stations. Tomah already has one.
"We're the eighth machine in Wisconsin," Burnstad said.
The machines use pipe tobacco, not roll-your-own tobacco. The step saves serious money: When the federal government raised tobacco taxes in 2009, it raised the roll-your-own tobacco tax from $1.09 per pound to $24.78 per pound but made the tax on pipe tobacco $2.8311 per pound.
RYO's website advertises a typical return on investment of 300 percent in the first year of use and a margin of 20 percent to 30 percent per "carton," as RYO describes the containers. The clear incentive for customers to use RYO machines is the promise of avoiding the federal and state excise taxes. Wisconsin's tax is among the highest in the nation; neighboring Illinois, Minnesota and Iowa have taxes of $0.98, $1.56 and $1.36 per pack, respectively.
Government's role
Governments have noticed the spread of commercial roll-your-own machines.
The Tobacco Tax Parity Act of 2010, introduced in the U.S. House of Representatives early last year, would have raised taxes on pipe tobacco to the same level as roll-your-own. It never got out of committee.
In October, the federal Alcohol and Tobacco Tax and Trade Bureau ruled that the rolling machines were being used for manufacturing and should be subject to taxes paid by name-brand tobacco manufacturers.
"The permit requirement is triggered by the manufacture of a cigarette by the commercial cigarette-making machine, which forms the tobacco into the roll and applies the cigarette paper or tube," the bureau said in its ruling. "The permit requirement is triggered regardless of whether the person operating the machine, by inputting loose tobacco and cigarette tubes, is an employee of the retail establishment or the ultimate consumer of the cigarettes manufactured."
Late last year, a federal judge in Ohio issued an injunction that prevented the bureau from carrying out its new policy, pending further court action.
On April 13, the New Hampshire Supreme Court heard arguments over a Brookline tobacco retailer's roll-your-own machine. According to an Associated Press report, lawyers for the state argued that customers left the store with cheap cigarettes that hadn't existed before they walked in, making the store a manufacturer that should pay into the national fund meant to offset costs of tobacco-related illnesses.
Lawyers for the company, North of the Border, said only customers might be manufacturing cigarettes, not the store, since the customers are paying a fee to use the store's machine, not buying cigarettes.
Stephanie Marquis, spokeswoman for Wisconsin's Department of Revenue, said whether excise taxes apply to RYO machines hasn't been determined but that the department and the state Department of Justice continually review laws to see if updates are needed.
"Those machines are fairly new," she said. "It's just an issue that's beginning to crop up with states."
Groups gather data
Ryan Sheahan, coordinator for the Tobacco Free Columbia-Dane County Coalition, said he wasn't sure that the machines would increase the number of smokers but instead might only shift spending from name brands to stores that offer the machines.
The coalition promotes smoking cigarettes cessation among youths and adults and the elimination of exposure to secondhand smoke, among other things. It conducts periodic compliance checks with tobacco sellers to test whether vendors will sell to youths, for example.
Sheahan said he was aware RYO machines have been moving into Wisconsin and other states. For now, he said, he'll gather data and consider increasing education efforts toward lawmakers.
"It's definitely an emerging market that we have to keep track of," he said.
Before Discount Smokes' first two weeks had passed, the owners said, they had had 130 runs.
One Discount Smokes customer, Stephanie Loufik of Rio, was described jokingly by Burnstad as "our favorite German customer."
Loufik said she'd spend about $60 at Kwik Trip for the particular brands of Marlboros she wants, about twice what she pays for a box at Discount Smokes. She noted the particulars of the store's process.
"You have the push the button as the customer," she said.
Regardless, the owners said the process was fairly easy to master.
"I had an 82-year-old lady in here the other day," Heinzel said. "No problem. She loved it."
The finished products aren't exactly Marlboros or Pall Malls. The owners said that's advantageous in some ways. The smokes don't have formaldehyde or plastics, they said.
"It's all natural," Burnstad said.
Heinzel said he switched to the RYO smokes and within a few weeks lost a bad hack. Chester said he doesn't smoke.
"I'm not against it," he said. "I just choose not to do it."
Chester said the three plan to soon open Discount Smokes branches in Baraboo, Wisconsin Dells, Lake Delton and Columbus.

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