IRS Did Not Abuse Discretion in Denying Accounting Method Change for Credit Card Fee Income

The Court of Federal Claims ruled that the IRS did not abuse its discretion by denying a request by American Express (AMEX) to change its method of accounting for annual credit card fee income (American Express Co., 47 Fed. Cl. 127 (2000)).

In 1987, AMEX requested the Service's consent to change its accounting method for annual credit card fee income from recognizing income on receipt to ratably including it over 12 months (as required by FASB Statement No. 91). The change was requested under Rev. Proc. 71-21, which allows deferred income recognition of payments received in one tax year for services to be performed in the following tax year. When the IRS denied the request, AMEX filed a refund claim. After the Service failed to act on the refund claim, AMEX petitioned the court for a refund, claiming the denial was an abuse of the IRS's discretion. The Court of Federal Claims held in favor of the Service on cross-motions for summary judgment.

Many credit card issuers have already addressed the tax treatment of annual credit card fee income. Like AMEX, credit card issuers that have attempted to defer recognition of fee income by requesting an accounting method change have likely experienced IRS resistance to such changes, despite Tax Court authority to the contrary.

In American Express, the court reasoned that the Service "enjoys broad discretion to determine whether a taxpayer's accounting methods clearly reflect income...and [the] exercise of this discretion must be upheld unless it is clearly unlawful." The court ruled that AMEX did not meet its burden of "persuading the court that the Service's decision was an abuse of discretion or clearly unlawful."

The court noted that GCM 39434 explained the IRS's position that annual credit card fees do not fit within the exception provided by Rev. Proc. 71-21, because they do not constitute payment for services. AMEX argued that GCM 39434 should be given no deference, because it merely stated the Service's litigating position and did not otherwise have precedential value. The court agreed that a general counsel memorandum is not authoritative precedent, but nevertheless held that the IRS could have reasonably used GCM 39434 for legal guidance. Accordingly, the court determined that GCM 39434 and Rev. Proc. 71-21 together provided the Service with an adequate basis for the decision that the annual credit card fees received by AMEX did not fall within Rev. Proc. 71-21's limited scope.

The court also disagreed with AMEX's argument that the Tax Court holdings in Barnett Banks of Florida, 106 TC 103 (1996) and Signet Bank, 106 TC 117 (1996), aff'd, 118 F3d 239 (4th Cir. 1997), require a lesser degree of deference to the IRS's position that annual credit card fees are not payment for services. In Barnett Banks, the taxpayer began charging an annual fee for its Visa cards at the same time it began providing additional services to cardholders. The annual credit card fee was refundable on a prorated basis if the card were canceled by either the taxpayer or the customer. The Tax Court held that the annual credit card fees were eligible for deferral under Rev. Proc. 71-21.

The facts in Signet Bank differed from those in Barnett Banks in that the annual fee was nonrefundable. In addition, the taxpayer in Signet Bank did not offer additional services when it introduced the annual fee, and the agreements between the taxpayer and its cardholders specifically stated that the annual fee was charged to establish the credit line provided by the card. Thus, the Tax Court held that the annual fees were not for services and could not be included in gross income on a deferred basis under Rev. Proc. 71-21.

Recognizing that the Tax Court decisions in Barnett Banks and Signet Bank "invite the court to make judgments based on close factual distinctions," the Court of Federal Claims stated that neither case fully addresses the question of whether the Service abused its discretion under Rev. Proc. 71-21.

From Kyle Klein, Washington, DC