Discussion:Overdraft Fees Not Deductible

It's not a large amount, but I've seen clients getting hit with high fees, especially as they try to stay afloat in this economy. Thought they were deductible. Any thoughts?

Simply ridiculous.

I just met with an auditor, the client's bank account showed deposits of 1.4M and he declared 800K of income. It's obvious to me that the client is simply putting draws back into the business account when checks bounce(ahem, due to the many cash withdrawals, subsequent checks bouncing for insufficient funds and corrective deposits). So of course the auditor says that unless we can prove the deposits are "recycled" using bank records, she will treat the excess deposits as unreported income. Argh. I can prove some of it by getting bank records of deposited items, but if it's cash all I have is client testimony which apparently is insufficient. Anybody have a creative way to deal with this? Or case law?

Also, copies of his deposit tickets would show the money being cash.

His deposit tickets don't specify cash or checks, but I think we can get the information from the bank, and also trace all the deposited checks to determine whether they are from personal accounts or from customers.

I once took money from one account at Commerce Bank here and deposited in another joint account. I asked the teller when it would be available and she replied 'tomorrow.' When I went to get a bank check on the second account that next day, it was not available and would not be for five days because I entered it as a check deposit. I was a little ticked off. Needless to say, when I opened a corporate account, and a joint account with my wife, we went across the street to the small Savings bank there.

Good luck, Tpasco.

Sad, however, that the agent will go to her next audit thinking that the fees are nondeductible...

Sometimes, principles are important!!! Fight for the $25 deduction.  :)

The deductibility of these charges might be dependent on the "size" of these fees.

One court case where the IRS prevailed on this was Bailey TC Memo 1991-385. Here is the headnote:

[start] Bank charges on overdrafts. Business expense deduction for bank charges on overdrafts was denied. Charges weren't proven to be ordinary or necessary to taxpayers' laundry and dry cleaning business or that such high amount of charges were normal, usual, or customary in taxpayers' business. Nor were charges deductible as interest for short-term loans[end]

Bailey had overdraft fees of $30K - deemed not ordinary & necessary. (Yes, that was $30,000 - not $25). Size was controlling.

In Grover, TCS 2008-64, the IRS sought to deny about $3,500 of these fees. The judge ruled otherwise. He cited Bailey but noted the fees were due to a lack of business acumen and were about 10% of what Bailey sought to deduct. While Summary cases can not be cited as precedent, show the case to the auditor and ask him/her what are the chances an Appeals Officer would sustain the disallowance of a $25 deduction????

Most small businesses occur these charges routinely. Unless, they were way out of line, I think they are ordinary & necessary.

"Petitioners were permitted to overdraw their Coastal Bank accounts as long as the amounts overdrawn were covered by deposits on the same day the overdraft occurred. Petitioners have not explained why they did not make deposits to cover checks written before they were presented. If they had the cash available to cover the checks, they could have avoided the bank charges. Petitioners' real reason for engaging in this peculiar pattern of conduct is undisclosed but, on the basis of the entire record, we cannot conclude that petitioners derived no personal benefit from their conduct or that the business nature of the payments made the bank charges ordinary and necessary." I think there always has to be some concern like that for a deduction to be denied on ordinary-and-necessary grounds.

I'm sure this is too late to help you but have you seen page 40 on pub 334.

Under other expenses you can deduct it lists "Bank Fees".

http://www.irs.gov/pub/irs-pdf/p334.pdf - IRS PUB 334 Tax Guide For Small Business

I hope this helps someone. Let us know the outcome.