The Illinois Interchange Fee Prohibition Act (IFPA) is one of the most targeted and technically nuanced state-level payment laws enacted in the United States. Unlike broad proposals to eliminate interchange entirely, the IFPA takes a narrower approach: it prohibits card networks and issuers from charging interchange fees on the portion of a transaction attributable to sales tax and gratuity (tips) when the merchant properly transmits that data.
While seemingly incremental, the law has meaningful financial, operational, and compliance implications — particularly for small and medium-sized businesses (SMBs), and especially for restaurants, hospitality providers, and retailers with significant taxable sales.
Brief Legislative and Legal Background
Legislative History
The IFPA was enacted in Illinois in 2023 following sustained pressure from merchant advocacy groups arguing that it is inequitable for card networks to collect interchange fees on:
- Sales tax — funds that merchants collect but do not retain, and
- Gratuities — amounts passed directly to employees.
The core policy argument was straightforward: merchants should not pay swipe fees on money that is neither revenue nor profit.
Litigation
Shortly after enactment, major card networks and banking trade associations filed suit in federal court, arguing that the IFPA is preempted by federal law, including:
- The National Bank Act,
- The Electronic Fund Transfer Act (EFTA), and
- Provisions of the Durbin Amendment.
The plaintiffs contended that allowing states to regulate interchange calculation components would interfere with nationally uniform card network operations.
A federal district court, however, declined to strike down the statute at the preliminary stage and allowed the law to proceed, signaling that state-level regulation of fee calculation components may survive federal preemption challenges. Appeals have been filed, but it is likely that the lower court’s ruling will stand – and merchants should prepare for this.
What the IFPA Actually Does
The IFPA does not eliminate interchange fees entirely.
Instead, it prohibits charging interchange on:
- The sales tax portion of a transaction, and
- The gratuity (tip) portion of a transaction,
provided the merchant separately identifies those amounts in the authorization and clearing messages transmitted through the payment system.
The remainder of the transaction — the actual goods or services — remains subject to interchange.
This distinction is critical for compliance and for accurately estimating financial impact.
Why This Matters for SMBs
1. Direct Cost Savings — Especially in Food & Hospitality
Restaurants, bars, salons, hotels, and delivery services are disproportionately impacted because tips often represent 15–25% of total transaction value.
Example:
- Total ticket: $100
- Goods/services: $75
- Sales tax: $5
- Tip: $20
Under IFPA, interchange would apply only to the $75 base amount, not the $25 attributable to tax and tip.
For a restaurant processing $2 million annually with an average 20% tip rate, exempting tips and tax from interchange could reduce effective processing costs meaningfully — often translating to thousands of dollars per year in savings.
For SMBs operating on thin 3–8% margins, this is not trivial.
2. Margin Protection on Non-Revenue Funds
From an accounting perspective:
- Sales tax is a liability account, not income.
- Gratuities are typically passed through to employees.
Yet under traditional interchange models, merchants pay fees on the full transaction amount.
The IFPA realigns fee assessment with actual merchant revenue, improving economic fairness and reducing cost leakage.
Operational and Compliance Requirements
The IFPA is not automatic. Merchants must ensure their systems are configured correctly.
1. Proper Data Transmission Is Critical
To qualify for the exemption:
- Sales tax must be separately identified in authorization and settlement messages.
- Gratuity must be properly itemized.
- POS systems may have to pass Level II or Level III transaction data where required.
If tax or tip is not transmitted correctly, interchange may still apply to the full amount.
This creates a technology dependency that SMBs must actively manage.
2. POS and Processor Coordination
Merchants should:
- Confirm with their acquirer/processor that systems can capture and send sales tax and gratuity in as part of the authorization and/or settlement records.
- Verify tax and gratuity data are properly coded.
- Review merchant statements to confirm interchange adjustments are applied once IFPA becomes effective.
Many SMBs operate on bundled pricing models where interchange is not transparent. Those on interchange-plus (IC+) pricing will more easily verify compliance and savings.
3. Statement Auditing and Controls
Given ongoing litigation and evolving guidance, merchants should:
- Conduct periodic statement audits.
- Maintain documentation showing tax and tip breakout compliance.
- Work with payments consultants or advisors to ensure processors are properly implementing the statute.
Strategic Implications if the Law Stands
If upheld on appeal, the IFPA will likely trigger acceleration of similar legislation in other states. Several legislatures have comparable proposals.
Potential Outcomes:
- State-by-State Fee Fragmentation
Card networks may need to apply different interchange calculation rules depending on transaction geography. - Acceleration of Transparent Pricing Models
Merchants may migrate toward IC+ pricing to capture and verify savings. - Technology Investment in Data-Level Processing
Processors will enhance tax/tip data recognition. - Network Response
Networks could adjust base interchange rates or introduce new assessment structures to offset lost revenue.
For multi-state SMBs, compliance complexity may increase. For single-state operators, cost relief may be meaningful and immediate.
Benefits for Merchants
If implemented effectively, the IFPA offers:
- Reduced processing costs without altering customer payment behavior.
- Improved fairness in fee calculation.
- Enhanced alignment between merchant revenue and fee basis.
- Potential negotiating leverage with processors.
Importantly, this reform does not require consumers to change payment methods — savings occur within existing card infrastructure.
Practical Steps for SMBs
To prepare and comply, merchants should:
- Review their POS configuration to confirm tax and gratuity breakout.
- Confirm with their processor how IFPA adjustments are implemented.
- Consider migrating to IC+ pricing for transparency.
- Audit monthly statements for compliance.
- Monitor legal developments, especially appellate decisions.
Looking Ahead
The IFPA represents a measured but symbolically powerful shift in the payment ecosystem. Rather than attacking interchange broadly, Illinois has targeted the most defensible component — fees charged on money merchants do not keep.
If courts ultimately uphold the statute, similar bills will likely gain momentum nationwide, reshaping interchange calculation methodology and introducing a new era of state-level influence over payment economics.
For small and medium-sized businesses, the message is clear: this is not just a legal story — it is a margin story. And in today’s operating environment, margin protection is workforce stability, growth capacity, and long-term resilience.
If you would like to learn more about the IFPA, related state bills, and impacts on your operations, we are here to help. Contact us at info@payments-roundup.com