Editor: Mark G. Cook, CPA, MBA
Gift cards and gift certificates have an appealing feature that makes them desirable to both givers and receivers—convenience. Nowadays, many gift cards are not limited to a specific retailer; some gifts cards are accepted by multiple merchants. Under prior law and guidance, revenue from gift card sales was recognized in the tax year of receipt. However, under regulations as modified and clarified by a series of revenue procedures, these revenues may be deferred in certain situations. On July 24, 2013, the IRS issued Rev. Proc. 2013-29, which allows taxpayers to defer income from the sale of gift cards or gift certificates redeemable by an unrelated entity until the cards or certificates are redeemed for goods and services by that entity. This modification is effective for tax years ending on or after Dec. 31, 2010.
In general, income is recognized in the tax year it is received by the taxpayer unless it is includible in a different period as a result of the taxpayer’s method of accounting (Sec. 451(a)). Under the accrual method, income is recognized in the period in which the taxpayer’s right to receive such income is fixed and the amount is measurable with reasonable accuracy (Regs. Sec. 1.451-1(a)). The taxpayer’s right to receive income is fixed on the date of the earliest of:
- Performance of the contracted goods or services;
- Due date of payment to the taxpayer; or
- Receipt of payment by the taxpayer (Rev. Rul. 84-31).
However, advance payments for goods may be deferred to the tax year the taxpayer recognizes the payment as income for internal or external financial reporting purposes (Regs. Sec. 1.451-5(b)(1)(ii)). Generally, taxpayers are limited to deferring income from advance payments for goods held by the taxpayer to the next subsequent tax year (Regs. Sec. 1.451-5(c)).
Rev. Proc. 2004-34 allows taxpayers to account for advance payments that include payments for goods and services using the full inclusion method or the deferral method. Under the full inclusion method, advance payments for goods and services are recognized as income in the tax year of receipt regardless of whether the payment is earned or recognized for financial reporting purposes (Rev. Proc. 2004-34, §5.01).
Rev. Proc. 2004-34 distinguishes two types of accrual-basis taxpayers under the deferral method: (1) taxpayers with an applicable financial statement and (2) taxpayers without an applicable financial statement. An applicable financial statement is a financial statement required to be filed with the SEC; a certified audited financial statement accompanied by an independent CPA report used for purposes of credit, reporting to shareholders, or any other substantial nontax purpose; or a financial statement provided to a federal or state government or agency other than the SEC or IRS (Rev. Proc. 2004-34, §4.06).
Under the deferral method, taxpayers with an applicable financial statement must recognize advance payments for goods and services as income in the tax year of receipt to the extent they are recognized in revenues in the applicable financial statement (Rev. Proc. 2004-34, §5.02). Taxpayers without an applicable financial statement must recognize advance payments for goods and services as income in the tax year of receipt to the extent it is earned. Any portion of the advance payment not recognized as income in the tax year of receipt must be recognized in the next subsequent tax year (Rev. Proc. 2004-34, §5.02).
For tax purposes, gift card and gift certificate sales are viewed as advance payments for goods and services. The general rules discussed above are mostly applicable in instances where the gift card is redeemable by the issuing taxpayer. Rev. Proc. 2011-18 allows taxpayers to use the deferral method for eligible gift card sales that are redeemable by another entity. For the gift card sale to be eligible for the deferral method, the taxpayer must be primarily liable for the value of the card until it is fully redeemed or reaches expiration. The gift card must also be redeemable by the taxpayer or another entity legally obligated to accept it as payment for goods and services.
Example: Company A operates department stores. Company B and Company C are wholly owned domestic subsidiaries of Company A and file a consolidated federal tax return under Company A’s consolidated group. Companies A, B, and C enter into a gift card service agreement under which Company A is primarily liable for the value of the gift card until redemption and Companies B and C are obligated to accept the gift card as payment for goods and services. Company A issues gift cards and reimburses Companies B and C for the sale price of the goods and services purchased with the gift card. The group recognizes revenue in its applicable financial statement when the gift card is redeemed. In year 1, Company A has $1 million of gift card sales. Company A tracks redemption of gift cards electronically and, through the consolidated group’s applicable financial statement, determines that $900,000 was redeemed in year 1. Under the deferral method, Company A recognizes $900,000 in income in year 1 and the remaining $100,000 in year 2.
Revenue recognition becomes more complicated when an unrelated taxpayer may also redeem the value of the gift cards. An unrelated entity is an entity whose financial statements are not consolidated with the taxpayer’s applicable financial statement (Rev. Proc. 2013-29, §2.04). If the gift card is redeemed by an unrelated entity, the revenue is earned and recognized by the unrelated entity upon the sale of goods or services. Therefore, under Rev. Proc. 2011-18, a taxpayer may not be able to use the deferral method because the taxpayer never recognizes income in its financial statements from the sale of gift cards redeemed by an unrelated entity, or in a case of a taxpayer without applicable financial statements, because the taxpayer never earns the payment for the gift cards.
Accordingly, Rev. Proc. 2013-29 modifies and clarifies the existing rules promulgated under Rev. Proc. 2011-18, which modified and clarified Rev. Proc. 2004-34, to provide that for gift card sales redeemable by an unrelated entity, sales are recognized in revenues in a taxpayer’s applicable financial statement to the extent the gift card is redeemed by the entity during the tax year, and for taxpayers without applicable financial statements, are earned by the taxpayer to the extent the gift card is redeemed by the entity during the tax year. The IRS stated in the revenue procedure that it had determined that a taxpayer should not be precluded from using the deferral method of accounting provided in Rev. Proc. 2004-34 solely because the taxpayer never recognizes in revenues in its applicable financial statement payments from an eligible gift card sale, or, for taxpayers without an applicable financial statement, never earns payments from an eligible gift card sale. However, gift card sales redeemable by the taxpayer or related entities are still subject to the maximum one-year deferral.
Mark Cook is a partner with SingerLewak LLP in Irvine, Calif.
For additional information about these items, contact Mr. Cook at 949-261-8600, ext. 2143, or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with SingerLewak LLP.