Tax accounting issues for gift certificates and gift cards.

• Author: Nesi, Nicholas A.

For a number of years, retail merchants have boosted their sales volume (and cash-flow) by offering gift certificates. More recent]y, they have either augmented their gift certificate programs or replaced them entirely with gift cards. Gift cards offer flexibility in promoting customer loyalty because they make it easier to track purchases and thus offer opportunities to enhance future sales.

Advance Payments

Depending on the laws of a particular state and the terms of gift cards or certificates (e.g., expiration dates), unredeemed gift cards or certificates can fall under a state's abandoned or unclaimed property (AUP) statute (i.e., the escheat Laws). Whether amounts attributable to unredeemed gift certificates or gift cards must be remitted to a particular state's AUP bureau should be reviewed by legal counsel.

For tax accounting purposes, receipts from the sale of gift certificates or gift cards are treated as "advance payments" under Regs. Sec. 1.451-5(a)(2). Generally, advance payments must be reported as income either (1) in the year of receipt or (2) in the year properly accruable under the taxpayer's method of (tax) accounting, provided they are reported no later than they would be for financial statement purposes. An exception to this general rule exists for advance payments under an agreement (such as a gift card or gift certificate) to sell inventoriable goods. Regs. Sec. 1.451-5(c) provides guidance when the taxpayer (1) accounts for advance payments for tax purposes under the method in Regs. Sec. 1.4515(b)(1)(ii), (2) receives "substantial advance payments" and (3) has on hand (or available through a normal supply source) goods of substantially similar kind and in sufficient quantity to satisfy the agreement. In such cases, the taxpayer must include in income all advance payments received under the agreement by the last day of the second tax year following the year in which it receives the advance payments.

Example 1: X, a calendar-year retail merchant, sold $100 of gift cards during December 2005, none of which was redeemed by the end of that year. Further, $80 in gift cards are redeemed during 2006, and $10 are redeemed during 2007. Under Regs. Sec. 1.451-5(c), X reports the following amounts for tax purposes:

Year Amount 1005 None 2006 $80 2007 $20 Although $10 remains outstanding at the end of 2007, it must be included in income no later than the last day of the second tax year following the year of receipt (i.e., Dec. 31...