(1) If a credit card issuer becomes entitled to a fee if it refuses to honor a credit card convenience check that, if honored, would leave the cardholder over the cardholder’s credit limit, is the fee interest income for federal income tax purposes?

(2) When is the credit card fee that is described in Issue (1) includible in gross income by the card issuer?

X, a taxpayer that uses an overall accrual method of accounting for federal income tax purposes, issues a credit card to A. The credit card allows A to access a revolving line of credit to make purchases of goods and services and to obtain cash advances, including cash advances obtained through A’s use of a convenience check made available through A’s credit card account (an “account check”).

There is a written agreement between X and A that sets forth the terms and conditions governing A’s use of the credit card (the “Cardholder Agreement”). Under the terms and conditions of the Cardholder Agreement, X is not required to honor one of A’s account checks if, when the account check is presented to X for payment, either A is overdrawn on A’s line of credit or payment of the check would cause A to become overdrawn. Under the agreement X is entitled to impose a $25 fee (the “Credit Card NSF Fee”) on A if an account check is presented to X that, if honored, would leave A overdrawn and X does not in fact honor the check (the “NSF Event”).

A writes an account check and uses it to make a payment to a third party. X does not honor A’s account check when the third party presents it for payment because A would be overdrawn on A’s line of credit if X honored the account check at that time. X is therefore entitled to impose a $25 Credit Card NSF Fee on A in accordance with the terms of X’s Cardholder Agreement with A.

For federal income tax purposes, interest is an amount that is paid in compensation for the use or forbearance of money. Deputy v. DuPont, 308 U.S. 488 (1940); Old Colony Railroad Co. v. Commissioner, 284 U.S. 552 (1932). Neither the label used for the fee nor a taxpayer’s treatment of the fee for financial or regulatory reporting purposes is determinative of the proper federal income tax characterization of that fee. See Thor Power Tool Co. v. Commissioner, 439 U.S. 522, 542-43 (1979); Rev. Rul. 72-315, 1972-1 C.B. 49.

When X determines that it will not honor A’s account check that the third party has presented for payment because A would be overdrawn on A’s line of credit, X is denying A the use of X’s funds. Thus, the $25 Credit Card NSF Fee does not compensate X for the use or forbearance of money, and it is not interest income for federal income tax purposes.

Under § 451(a) of the Internal Revenue Code, the amount of any item of gross income is includible in gross income for the taxable year in which it is received by the taxpayer, unless that amount is to be properly accounted for in a different period under the method of accounting used by the taxpayer in computing taxable income.

Under § 1.451-1(a) of the Income Tax Regulations, income is includible in gross income by a taxpayer that uses an accrual method of accounting when all events have occurred that fix the taxpayer’s right to receive that income and the amount of that income can be determined with reasonable accuracy. See also § 1.446-1(c)(1)(ii)(A). Generally, all the events that fix the right to receive income occur either when the required performance takes place, when payment is due, or when payment is made, whichever occurs first (the “All Events Test”). See, e.g., Rev. Rul. 2004-52, 2004-1 C.B. 973 (addressing credit card issuers’ treatment of credit card annual fees).

X is required to include the Credit Card NSF Fee in gross income under section 451 when the NSF Event occurs because the NSF Event fixes X’s right to receive the income and the amount can be determined with reasonable accuracy. Thus, the All Events Test is satisfied when the NSF Event occurs.

A change in the treatment of Credit Card NSF fees to comply with this revenue ruling is a change in method of accounting within the meaning of §§ 446 and 481 and the regulations issued thereunder. Accordingly, a taxpayer wishing to change its treatment of Credit Card NSF fees to comply with this revenue ruling must obtain the consent of the Commissioner under § 446(e) and § 1.446-1(e)(2)(i) by following the procedures in Rev. Proc. 97-27, 1997-1 C.B. 680 (or its successor).

(1) The Credit Card NSF Fee is not interest for federal income tax purposes.

(2) The Credit Card NSF Fee is includible in gross income for federal income tax purposes when the NSF Event occurs.

The principal authors of this revenue ruling are Jonathan Silver and Tina Jannotta of the Office of Associate Chief Counsel (Financial Institutions & Products). For further information regarding this revenue ruling, contact the principal authors at (202) 622-3930 (not a toll-free call).