What expense category is Foreign Currency Exchange Fees and Losses?

In a global economy, businesses frequently pay vendors, purchase supplies, or make sales in foreign currencies. These international transactions often incur specific costs, including explicit bank fees and potential losses due to fluctuating exchange rates. For accountants and business owners, it's essential to know that these costs are generally deductible.

Correctly categorizing these expenses is key to accurate financial reporting and tax compliance. This guide explains how to treat foreign currency fees and transaction losses in accordance with IRS principles and how to track them effectively.

Foreign Currency Exchange Fees and Losses Category

The IRS does not provide a single, dedicated expense category for all foreign currency costs. Instead, they are treated as ordinary and necessary business expenses and categorized based on their nature.

• Foreign Currency Exchange Fees: Explicit fees charged by a bank or credit card company for converting currency are deductible. They are best classified as Bank Fees or as a specific line item under Other Expenses.
• Transaction Losses: A loss that occurs because of a change in the currency exchange rate between the time you record a transaction and the time you settle it is a deductible business loss. This is also reported under Other Expenses.

Important Considerations When Classifying Foreign Currency Costs

The key to handling these expenses is to understand the distinction between a direct fee and a loss due to currency valuation.

Realized vs. Unrealized Losses

A loss from a foreign currency transaction is only deductible when it is realized. A loss is realized when the transaction is complete, for example, when you pay an invoice in a foreign currency or when a customer pays you and you convert the funds to U.S. dollars. You cannot deduct unrealized or paper losses on foreign currency you hold that has not yet been converted or used.

Separating Fees from Transaction Losses

It is critical to account for these two costs separately.

• A foreign transaction fee is a specific charge from a financial institution for the service of converting one currency into another.
• A transaction loss is the financial shortfall resulting purely from a change in the exchange rate.

For example, if you pay a vendor in Euros, your bank may charge you a wire fee and a currency conversion fee. Separately, if the value of the Euro increased between when you received the invoice and when you paid it, you would also have a transaction loss. Both the fees and the loss are deductible, but they should be tracked as distinct items.

Functional Currency

The IRS requires U.S. businesses to keep their books and file their tax returns in their functional currency, which is almost always the U.S. dollar. Therefore, all transactions made in a foreign currency must be translated into U.S. dollars for your records.

Examples of Foreign Currency Expenses

• Deductible Fee: You use your business credit card to purchase supplies from a supplier in the United Kingdom for £100. Your credit card company charges a 3% foreign transaction fee. This fee is a deductible business expense.
• Deductible Loss: Your U.S.-based company invoices a client in Japan for ¥1,500,000. On the date you issue the invoice, you record $10,000 of revenue based on the exchange rate. A month later, when the client pays, the exchange rate has shifted, and the ¥1,500,000 payment converts to only $9,800. The $200 difference is a deductible business loss.

Tax Implications and Recordkeeping

To deduct these costs, you must report them correctly and maintain meticulous records.

How to Report the Deduction

For a sole proprietor filing a Schedule C (Form 1040), foreign currency exchange fees and transaction losses are deducted under Part II, Line 27a, Other expenses. It is best practice to list them separately, for instance, as Bank Fees and Foreign Currency Loss.

What Records to Keep

Your records must be able to substantiate the loss or fee. For transactions involving currency conversion, you should keep documentation showing:

• The date of the transaction (e.g., invoice date).
• The amount in the foreign currency.
• The exchange rate on the transaction date.
• The date of settlement (payment).
• The exchange rate on the settlement date.
• Any bank or credit card statements detailing explicit foreign transaction fees.

How Fyle Can Automate Tracking for Foreign Currency Expenses

Fyle simplifies the complex task of tracking international expenses, ensuring that every fee and transaction is accurately captured for tax time.

• Handle Multi-Currency Expenses: Fyle automatically converts expenses made in any foreign currency to your home currency (U.S. dollars) for easy reporting and tracking.
• Capture Real-time Data: Fyle’s real-time credit card feeds instantly capture international transactions, including any foreign transaction fees charged by the bank.
• Centralize All Documents: Employees can attach the original foreign-currency invoice or receipt to the expense in Fyle, creating a complete record for your accountant.
• Automate Your Accounting: Fyle syncs the fully coded expense and any associated fees directly to the proper GL accounts in QuickBooks, Xero, NetSuite, or Sage Intacct.