Trends & Developments - June 2011 - Tax Consequences of Issuing Gift Cards and Store Credit
Retailers often receive payments from customers before the customers select the items they wish to purchase. For example, most retailers now sell gift cards or certificates which enable the holder, usually the recipient of a gift, to redeem the gift cards/certificates at a later time. In addition, many retailers will issue a gift card, certificate or store credit usable only with the retailer, instead of a refund, when customers return items they previously purchased and are unable to produce a receipt or other proof of purchase.
The tax law provides favorable treatment to such retailers by allowing them to defer the recognition of taxable income either to the next taxable year after the gift card, certificate or credit is issued (Revenue Procedure 2004-34), or to the second taxable year after it is issued (Section 1.451-5 of the Income Tax Regulations), or when it is redeemed if earlier, as long as various conditions are satisfied.
Several examples may help to illustrate this favorable tax deferral and the required conditions:
Example 1: XYZ Sports Company sells sporting goods at its various locations and has the same year for both financial statement and tax purposes. For a number of years XYZ has been selling gift cards that can be used to purchase items it carries in its inventory. The gift cards provide no expiration date, and XYZ has been recognizing the full amount received for a gift card in taxable income in the year the gift card is issued, although for financial statement purposes it recognizes in revenue each year only that portion of the full amount of each gift card sold that is actually redeemed in that year. Under these facts, XYZ would be able to change its tax "method of accounting" (the timing of an income or expense item) from its present method of recognizing gift card income all in the year the gift card is issued to either (1) recognizing in income in the year the gift card is issued only the portion recognized for financial statement purposes, with the remainder all recognized in the following year, or (2) recognizing in income in the year of issuance and the following year that portion recognized for financial statement purposes, with the remainder all recognized in the second taxable year following the year of issuance.
Example 2: Same facts as in Example 1, except that XYZ uses another company to sell its gift cards and operate its gift card program. Because the gift card company is selling gift cards for the purchase of goods that it does not maintain as its own inventory for the sale to customers, it can only use the method of accounting allowing it to recognize in the year the gift card is issued the portion recognized for financial statement purposes, or otherwise earned, with the remainder recognized in the following year. (Qualification for this one-year deferral was confirmed by the Internal Revenue Service in Revenue Procedure 2011-18 issued in January of this year.) If XYZ enters into service contracts with its customers for the repair of items sold, it also would be able to use this one-year deferral method with respect to amounts received upon the issuance of service contracts.
Example 3: Customers of XYZ may return goods purchased and receive a refund if they can produce a receipt or other proof of purchase. If not, they can receive a gift card or credit from XYZ equal to the current sales price of the goods returned. The return of goods for a gift card or credit is treated as if the customer receives a refund in the amount of the gift card or credit for the goods returned (resulting in an offset or reduction to the income previously recognized by XYZ upon the original sale of the goods returned) and then purchases the gift card or credit received, resulting in the same tax treatment to XYZ as in Example 1. (This treatment was confirmed by the Internal Revenue Service in Revenue Procedure 2011-17 issued in January of this year.)
If your business is a taxpayer described in one or more of the above examples and is currently recognizing taxable income when you issue a gift card, certificate or credit, an EisnerAmper LLC tax professional can assist you to determine whether you qualify for the one and/or two-year deferral described above and in filing with the Internal Revenue Service an application to change your method of accounting.
Trends & Developments – June 2011
- M&A, Restructuring and Other Transactions: Tax Treatment of Investigation and Pursuit Cost
- Rewarding Key Employees of Closely Held Businesses — Phantom Equity and Section 409A
- Disclosure of Possible Losses
- Tax Consequences of Issuing Gift Cards & Store Credit
- Demystifying the Alternative Minimum Tax