Is a merchant's returned/bad-check fee taxable, and does the answer change when the debt is turned over to an outside collection agency?

Plain-English summary

A merchant wrote to the Comptroller asking about the tax treatment of returned-check fees under four different scenarios, ranging from handling a bad check entirely in-house to turning it over to an outside collection agency.

The Comptroller's answer turns entirely on who is doing the collection work. If the merchant simply charges its own $25.00 returned-check fee and never involves an outside collection agency, that fee is not taxable. But once an outside collection agency is brought in -- whether the customer pays the agency directly, or pays the merchant who then forwards the money to the agency -- the portion of the fee attributable to the collection agency's services is taxable, because debt collection services are a taxable service in Texas.

The letter also addresses a hybrid scenario: the merchant notifies a collection agency of the bad check (so the customer is flagged and can't keep writing bad checks elsewhere) but does not formally turn the account over to the agency, and the customer pays the merchant directly. In that case, only the slice of the fee that is actually passed along to the collection agency is taxable; the portion the merchant keeps for itself remains non-taxable.

In short, the ruling draws a clean line: a merchant's own in-house handling fee is not a taxable service, but any amount that compensates a third-party collection agency for its collection services is taxable, regardless of which party physically hands over the money.

What this means for you

Retailers and merchants charging bad-check fees

If you charge customers a flat returned-check fee and handle collection entirely yourself, that fee is not taxable. The moment you involve an outside collection agency -- even just to notify them so the customer can't pass bad checks elsewhere -- you need to separately account for the portion of the fee that goes to the agency, because that portion becomes taxable.

Businesses that use collection agencies

If your collection process involves a third party, keep records showing how much of any fee collected from the customer is actually remitted to the collection agency versus retained by your business. Only the remitted portion is taxable; you should not be charging tax on the full fee if you're also keeping part of it for yourself.

Accountants and tax professionals

This ruling is a useful example of Texas taxing debt collection services performed by a third party, while treating a business's own internal fee-collection efforts (handled without an outside agency) as non-taxable. When advising clients who mix in-house and outsourced collection, the fee needs to be split and only the collection-agency portion taxed.

Common questions

Q: Is a merchant's own bad-check fee taxable if no outside collection agency is used?
A: No. The letter states plainly that the fee is not taxable when the merchant handles the returned check itself without turning it over to an outside collection agency.

Q: What if the customer pays the fee directly to my store instead of to the collection agency?
A: It doesn't matter who physically collects the money. If any portion of the fee is given to (or intended for) the collection agency for its services, that portion is taxable, even though the customer paid the store rather than the agency.

Q: We notify a collection agency about a bad check but don't formally turn the account over to them -- is the full fee taxable?
A: No. Only the part of the fee that is actually given to the collection agency is taxable; the remainder that the merchant keeps is not.

Q: Does this ruling cite specific statutes?
A: No, the letter does not cite any Texas Tax Code or Administrative Code provisions by section number -- it simply applies the general rule that debt collection services are taxable while a merchant's own fee-collection is not.

Source

• STAR search: https://star.comptroller.texas.gov/search?doc_type_code=L&tax_type_code=SST
• Opinion: https://star.comptroller.texas.gov/view/9205192L

Original ruling text

May 13, 1992

Dear **:

Thank you for your letter of April 30, 1992, concerning the taxability of debt
collection activities. Your questions are restated below with responses.

(1) We, the merchant, charge a $25.00 return check fee. The returned check is
not sent to an outside collection agency. Is this fee taxable?

Response: The fee is not taxable.

(2) We, the merchant, turn over the returned check to an outside collection
agency. Is this fee taxable?

Response: The fee charged by the collection agency is taxable.

(3) We, the merchant, turn over the returned check to a collection agency;
however, the customer does not want to pay the collection agency directly and
comes in to our store to pay the fee. The fee is given to the collection
agency. Is this fee taxable?

Response: The amount given to the collection agency for payment of their
services is taxable.

(4) We, the merchant, do not turn over the returned check to a collection
agency; however, the collection agency is notified of the returned check so the
customer is stopped from writing checks in other places. The customer pays the
store directly for the full returned check fee. Part of the collection fee is
given to the collection agency. Is the full return check fee taxable?

Response: Only the portion of the returned check fee that is turned over to the
collection agency is taxable.

This opinion is based on the facts presented. If there are any additional or
different facts, the opinion may change.

If you have any questions or need additional information, you may call toll
free 1-800-252-5555 Ext. 50037 or the regular Austin number is 512-475-0037.
You may also write to Tax Administration Division.

Sincerely,

Lindey Osborne
Administration Division