Accounting for customer loyalty programs: opportunities and pitfalls.

• Author: Van Leuven, Mary

The use of customer loyalty programs as a way of attracting and retaining customers has greatly expanded in recent years. As these loyalty programs continue to grow, so do the costs of providing loyalty rewards to customers. Thus, the federal income tax implications surrounding these programs are more relevant than ever. An often overlooked regulation may offer substantial benefits with respect to the treatment of redemption costs for taxpayers with loyalty programs.

Regs. Sec. 1.451-4 provides a method of computing net income for taxpayers that issue or sell qualifying trading stamps or premium coupons that are redeemable by that taxpayer for merchandise, cash, or other property. The regulation allows accrual-method taxpayers to subtract from gross receipts with respect to sales (of trading stamps for trading stamp companies or other items for non trading stamp companies) an amount equal to (1) the cost of redemptions in the tax year and (2) estimated future redemptions.

Because Regs. Sec. 1.451-4 permits taxpayers to take into account the cost of future redemptions in the year the trading stamps or premium coupons are issued, applying the regulation may result in an accelerated recognition of redemption costs compared to what would otherwise be available under the general expense recognition rules of Sec. 461. Thus, for taxpayers that experience a significant lag between issuing and redeeming loyalty points, the regulation can be a beneficial method of accounting for redemption costs.

Eligibility to Use the Method

Trading stamp companies: Trading stamp companies are eligible to use this method of accounting. The Sperry and Hutchinson Co. (vendor of S&H Green Stamps, now called S&H Greenpoints) is the classic example of a trading stamp company. Taxpayers are considered trading stamp companies if:

* The trading stamps or premium coupons are issued by purchasers to promote the sale of the purchasers' merchandise or services;

* The principal business activity of the taxpayer is the sale of stamps or coupons;

* The stamps or coupons are redeemable by the taxpayer for at least one year from the date of the sale; and

* Based on the taxpayer's experience, no more than two-thirds of the stamps or coupons sold that are expected to be redeemed will be redeemed within six months of the date of sale (Regs. Sec. 1.451-4(a)(2)).

Non-trading stamp companies: Taxpayers that issue trading stamps or coupons with sales (rather than sell the stamps or coupons as their primary product) also may be able to use this method. For instance, a retailer may reward customers with loyalty points for buying merchandise. A customer who accumulates enough loyalty points may redeem them with the retailer for...