I just wanted to get some opinions (aned if anyone has a site that would be helpful). I have a client who has many thousands in NSF fees.
Back when I was a Tax Auditor, many years ago, I used to disallow NSF fees but was told by review or appeals that they had to be allowed. My client has heard they were not allowable so I'm comfortable not including this expense. I was just hoping someone might have more recent experience with this issue.

asked 15 May '10, 23:52

Toni%20McIntyre%20CPA's gravatar image

Toni McIntyr...
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Once again this proves that there will always be legitimate differences of opinion and intepretation among educated professionals. I see I disagree with most of my esteemed colleages responses. Here's my take -

Taxpayers are allowed to deduct all ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business - IRC Sec 162

To be deductible, an expenditure must meet both requirements - it must be BOTH ordinary and it must be necessary.

Ordinary in this context means normal, usual or customary. It does not imply that the expense must be habitual or normal in the sense that the taxpayer must incur it frequently. Rather, it refers to expenses that are normally or customarily incurred in response to a particular circumstance. An expense may be ordinary although it happens only once in a taxpayer's lifetime. Welch v. Helvering, 290 U.S. 111 (1933). The determination depends on whether the expense is one that has occurred or could occur in connection with businesses similar to the business claiming the expense deduction.

Necessary generally means appropriate and helpful as opposed to required or obligatory. Again see Welch v. Helvering, 290 U.S. 111 (1933). An expenditure is necessary if it is appropriate and helps develop and maintain the taxpayer's business.

Although there is no express provision limiting ordinary and necessary expenses to a reasonable amount, the element of reasonableness generally is considered to be inherent in the ordinary and necessary requirement. This has been confirmed by several court cases includingg - Commissioner v. Lincoln Elec. Light Co., 176 F.2d 815 (6th Cir. 1949), cert. denied, 338 U.S. 949 (1950).

Thus, taxpayers generally cannot deduct excessive payments as ordinary and necessary business expenses. Limericks, Inc. v. Commissioner, 165 F.2d 483 (5th Cir. 1948). Whether an expense is reasonable is a question of fact.

In Bailey v. Commissioner, T.C. Memo. 1991-385, the Tax Court disallowed bank overdraft charges which in 2 of 3 years exceeded $30,000. The Court observed that the taxpayers continued their practice of incurring and paying overdraft charges over a 3-year period, and the total amounts paid were substantial. The taxpayers argued that they were having financial difficulties and that they would intentionally overdraw their bank account as a substitute or alternative to borrowing funds. The Court rejected the taxpayers' argument and disallowed the deduction of excessive overdraft fees.

So we have to look to the facts and circumstances of the case at hand. The taxpayer has "many thousands in NSF fees". I believe there is no question that they are ordinary and necessary as most businesses will have some such fees from time to time, but are they reasonable under the circumstances? If so, deduct them. But if your client is using NSF fees as a means to borrow money you could find that they get disallowed under audit.

As a side note, you should not advise a client to play the audit lottery - doing so is an ethical violation. However, that does NOT mean that you should leave off a deduction that you believe to be legitimate.

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answered 19 May '10, 19:01

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EAgent
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1

That last part is good advice to others. Having been the one doing the auditing for many years it has taken me awhile to go from deducting only what I would have allowed (I was the toughest auditor I knew) to what I know I can get appeals to allow. Fortunately, as I mentioned, my client has heard it might not be allowable so he won't be too surprised that I will not deduct it. He has bad credit so was treating it as a loan.

(20 May '10, 14:30) Toni McIntyr...

I agree with EAgent's summary. In Grover v. Commisisoner, T.C. Summary Opinion 2008-64, the court noted "Petitioner’s overdraft charges were not the result of intentional acts but a lack of acumen. By comparison, the overdraft charges he incurred for 2002 were substantially less than (10 percent of) the charges in Bailey. Each business may incur some expense due to carelessness or lack of ability, and in this case we do not find the amount to be unreasonable." This has the three criteria EAgent noted above: 1) Ordinary 2) Necessary and 3) Reasonable.

(22 Aug '10, 05:52) Rick 1

For a business, I have no problem taking them as an expense.

Helen, EA in PA

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answered 16 May '10, 01:22

Helen%20EA%20in%20PA's gravatar image

Helen EA in PA
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I agree with Helen, expense them. They are not any different than any other bank fee. You shouldn't confuse them with fines or penalties.

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answered 16 May '10, 02:43

Stephen%20Ashby%20CPA's gravatar image

Stephen Ashb...
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I think people get confused because "fines and penalties" are not allowed as business deductions. But Sec 162(f) says:

Fines and penalties

No deduction shall be allowed under subsection (a) for any fine or similar penalty paid to a government for the violation of any law.

As overdraft fees don't fall into that category, I think they are legitimate expenses.

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answered 17 May '10, 02:06

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Tom
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I myself do not take them as legitimate. They have a "choice" but if they fail to have enough funds, then essentially, why would you be allowed to deduct it?

I put credit card penalties and o/d fees in non deductible. Maybe I am too conservative

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answered 17 May '10, 20:32

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SandySea
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So if someone bounces a check to me for $10K and causes me a $1K overdraft, that is my choice? Just playing the devil!

(19 May '10, 22:05) Helen EA in PA

If you're writing a check against uncleared funds and incur a NSF fee, that is your "choice" (or inattention to detail).

If the client's check is returned and your bank charges a bad check fee, that's not an NSF fee.

(20 May '10, 13:57) Tom

Helen :).....I agree if a client bounces a check to you, then you charge them the NSF fee no? If they will not pay, then yes, I think this is legitimate. Only if you bounce checks; it is your choice to not do accounting for your $$$. To me this is a penalty for failure to manage your funds. :)

(20 May '10, 16:24) SandySea
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Asked: 15 May '10, 23:52

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Last updated: 19 May '10, 19:01