Iowa Sales Tax on Financial Institution Service Charges? Obviously?

Like most states, Iowa does not tax services unless they are specifically enumerated.  The long list of taxable services in Iowa Code § 423.2(6) includes the obvious (#sarcasm) “Turkish baths” and “reducing salons”.  The list also includes the not so obvious “service charges of all financial institutions.”  While all Turkish baths and reducing salons are subject to tax, not all charges by financial institution are created equal.  

As is usually the case with Iowa sales and use tax, the Iowa Department of Revenue took it upon itself to further define statutory terms via administrative rule. In this case, the rule includes a narrow interpretation of the term “service charge.”  Iowa Admin. Code r. 701—26.8(2) limits the definition of “service charges” to those “which relate to a depositor’s checking account.” However, that same rule takes a broad view of what qualifies as a checking account:

• “The term ‘checking account’ is characterized with reference to its common meaning.” 
• An account “is a ‘checking account’ if withdrawal may be made from the account by a written instrument, including, but not limited to, instruments such as a check, a draft, or negotiable order of withdrawal (NOW).” 
• “The above definition is meant to be illustrative only.”

Interestingly, the same service performed by a financial institution could be taxable or not taxable depending on whether the service was performed or not performed in relation to a checking account.  This is, of course, not obvious from reading the statute (#seriously).  The key is to determine whether the service charge relates to a checking account, which could include:

• Stop payment charges
• Debit card replacement fees
• Copy and research fees
• Bill payment fees, returned deposit item fees

Once a financial institution has determined the taxability of its fees, it must then determine where the transaction occurs (or is “sourced”), which could affect the tax rate to be charged. Under Iowa Code § 423.15, service charges are sourced where the first use of the service occurs.  Generally speaking, with respect to bank service charges other than taxable ATM fees, the service would be sourced to the address of the customer. Taxable ATM fees would be sourced to the location of the ATM.  Perhaps causing confusion regarding sourcing of service charges are the Department’s outdated, publicly available policy letters (here, here, here) indicating that the service charges should be sourced to the location that the service is performed rather than where the service is first received. To be clear, financial institution service charges should be sourced under a destination regime, which requires a determination where the service is received, first used, or could potentially first used by the purchaser.  See Iowa Admin. Code r. 701—223.2.

So, what seems obvious from a review of Iowa’s statute, is not obvious at all.  A financial institution’s service charge is taxable only if it relates to a checking account. And, the financial institution must source such charges to the proper location—where the service is first received.  

The material in this blog is not intended, nor should it be construed or relied upon, as legal advice. Please consult with an attorney if specific legal information is needed.

- Cody Edwards