A federal judge paused parts of Illinois’s Interchange Fee Prohibition Act in December 2024, shielding nationally chartered banks while litigation continues. The statute, if fully enforced on its July 1 2025 start date, would forbid card networks from charging interchange on sales-tax or tip amounts, according to WGEM.

Indiana legislators responded in January 2025 with Senate Bill 412, which mirrors the Illinois design and proposed fines of up to 1,000 dollars for every non-compliant transaction, as shown on LegiScan. The twin measures spotlight a merchant grievance often called “a three-percent tax on taxes” and expose design limits inside the six-decade-old card system.

Executive Summary


  • Illinois and Indiana moved to bar interchange fees on sales-tax and tip amounts; Illinois enforcement is partly enjoined in federal court.
  • Card networks transmit each purchase as a single amount, so separating tax and gratuity would require expensive work-arounds.
  • Payments technologists argue that protocol-native settlement using stablecoins and verified identity can split proceeds, taxes and fees at the moment of payment.
  • Visa announced 2025 expansions that let acquirers and issuers settle in USD-backed stablecoins.
  • Legislative pressure may shift merchant efforts from fee negotiations toward wholesale infrastructure change.

Why Swipe Fees Became a Target


Interchange fees commonly hover around two percent of the total ticket, a level the U.S. Government Accountability Office documented in a 2010 report that traced steady growth across retail segments. Because the fee applies to every dollar that travels through the card rail, merchants also pay it on money they merely pass to state coffers.

Large retailers say the practice inflates costs that are already rising with card acceptance. A moderate-sized chain processing 1 billion dollars in annual card volume could easily remit tens of millions in sales taxes; if three percent attaches to that sum, the hidden charge rivals some firms’ net profit margins.

Political interest in the topic is not new. Senator Dick Durbin, a longtime critic of interchange pricing, filed a 2025 amicus brief supporting the Illinois statute and wrote that it would deliver “urgently needed relief” from excessive fees. State lawmakers have now picked up the cause, arguing they can act more quickly than Congress.

Banks and processors counter that interchange reflects fraud risk and credit funding costs and say legislatures underestimate the technical changes needed to isolate tax and gratuity inside current message formats.

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The State-House Offensive


Illinois enacted the Interchange Fee Prohibition Act to stop networks from taking a cut of money that never belongs to merchants. A guidance note by Ryan LLP explains that processors failing to refund the excess could owe restitution and civil penalties.

Two lawsuits, consolidated in the Northern District of Illinois, argue that federal law pre-empts the ban for national banks. The court’s preliminary order applies only to those banks, leaving state-chartered institutions and independent processors in a regulatory gray zone as the July deadline approaches.

Indiana’s Senate Bill 412 extends the same idea and adds a sharper enforcement hook: fines can reach 1,000 dollars per violation. Merchants welcomed the bill’s introduction, estimating seven-figure annual savings, while banking groups testified that compliance would force costly system rewrites.

Whether the courts uphold either statute, the debate has already forced payment firms to examine the infrastructure that decides how fees are assessed and who ultimately pays them.

Technical Barriers in Legacy Systems


Most card transactions travel a four-party model that links the merchant, an acquiring bank, the issuing bank and the network. The ISO-8583 message sent at the point of sale carries only a single amount field, so the network applies its percentage to the entire sum.

Industry affidavits filed in the Illinois case state that no existing production system can tag tax or tip in real time. To comply, processors would need parallel databases that match point-of-sale records with settlement files, identify tax lines and rebate a portion of the interchange after the fact.

That approach erodes one of card payments’ chief attractions: near-instant funding. If acquirers must hold transactions until they verify offsets, merchants could face delayed access to cash or higher service charges that offset any statutory savings.

Banks also argue that federal regulation of nationally chartered institutions bars states from dictating network fees. The courtroom dispute and the technical impasse together create an expensive stalemate.

Protocol-Native Settlement as Alternative


Payments engineer Jay Smith calls the legacy network a “dumb pipe” that cannot inspect a transaction’s components. In a November 2025 LinkedIn thread he wrote, “Trying to fix this with legislation is like trying to fix a fax machine with a software update.”

Protocol-native settlement reverses the model by embedding rules in software rather than contracts. A stablecoin transfer moves digital dollars on-chain while a smart-contract split routes product revenue to the merchant, sales-tax proceeds to the state treasury and any fee only on the net sale.

Identity checks bind each wallet to a verified entity, meeting anti-money-laundering standards and giving treasurers confidence that funds land in the correct account immediately. The process yields an auditable trail available without subpoenaing processors.

Because the fee is applied only to the principal, merchants avoid paying interchange on money they never keep. The design also eliminates post-transaction reconciliation, reducing back-office costs that card processors currently absorb or pass along.

Industry Movement Toward New Rails


Large networks are already testing on-chain payout models. Visa expanded its digital-asset settlement platform in July 2025, adding more USD-backed stablecoins and blockchains for issuer and acquirer transactions.

Reuters Breakingviews reported in August 2025 that growing stablecoin volumes now "vex" the long-standing Visa-Mastercard duopoly, framing blockchain rails as both threat and opportunity. Incumbent firms appear keen to integrate rather than cede volume.

Several acquiring processors have announced pilot programs that let merchants receive stablecoin settlement the next day while still taking conventional card payments at the register. The initiatives suggest a phased approach: keep consumer-facing interfaces unchanged while modernizing the treasury leg.

For merchants, early signals matter. If on-chain settlement reliably cuts reconciliation time and fee exposure, boards may redirect lobbying budgets toward migration costs, echoing Smith’s argument that capital is better spent on a new system than on a better contract.

Implementation Challenges and Considerations


Stablecoin issuers face evolving federal requirements on reserve transparency and consumer redemption rights. The GENIUS Act, enacted in July 2025, requires one-to-one reserves, monthly independent attestations, and custody at regulated institutions, adding costs that could flow into merchant pricing.

Consumer adoption depends on wallet design. A checkout flow that forces shoppers to manage cryptographic keys may deter use, while a wallet embedded in familiar mobile banking software could mask the complexity and widen uptake.

Hardware also matters. Many retail terminals lack native support for scanning blockchain addresses or QR codes. Bridge software can route a tap-to-pay signal through existing card rails and convert in the background, but full efficiency gains arrive only when devices speak directly to the new network.

Finally, a patchwork of state rules complicates compliance for national chains. A protocol that remits tax to the correct jurisdiction in real time may help, yet only if regulators deem the automated record equivalent to current reporting standards.

Looking Ahead


Illinois and Indiana may resolve their legal fight before processors rebuild card infrastructure to honor tax carve-outs. By that time, merchants could already be running enough volume through tokenized rails to render the dispute academic.

If protocol-native settlement scales, the question may shift from “who pays interchange on tax” to “which rail enforces split-second compliance at the lowest cost.” Legislatures sparked the pivot, but market adoption will determine how far the transformation goes.

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