Customer reward programs: deducting fulfillment costs prior to economic performance.

• Author: Takacs, Natalie B.

Regs. Sec. 1.451-4 provides a narrowly construed exception to the economic performance rules that allows accrual-basis taxpayers who issue premium coupons (or trading stamps) to deduct the estimated fulfillment cost of the coupons (or stamps) at the time they are issued. Taxpayers desiring to take advantage of this favorable treatment must be careful to distinguish their coupon programs from rebates, for which economic performance does not occur and no deduction is allowed until the rebates are actually paid (see Regs. Sec. 1.461-4(g)(3)). To qualify for the favorable treatment for premium coupons available under Regs. Sec. 1.451-4, taxpayers must issue them "with sales," and the coupons must be "redeemable by Ethel taxpayer in merchandise, cash, or other property."

Premium Coupons

The term "coupon" is not defined in Regs. Sec. 1.451-4; however, in Texas Instruments, Inc., T.C. Memo. 1992-306, the Tax Court noted a dictionary definition of "4a token or certificate given with a purchase and redeemable in merchandise or cash' and a `trademark, wrapper, box top, or similar evidence of a purchase for which premium articles are given." In Chief Counsel Advice 200826006, the IRS held that a single-coupon rebate was not a premium coupon eligible for favorable treatment under Regs. Sec. 1.451-4. Referring to the Blue Book explanation of the Revenue Act of 1978, P.L. 95-600, for Sec. 466 (later repealed by the Tax Reform Act of 1986, P.L. 99-514), the IRS Chief Counsel's Office distinguished "discount coupons," which are individually redeemable, from premium coupons, which are "intended to be collected and redeemed in large numbers for a single product." Based on this definition of premium coupons, customer reward programs (modeled on the affinity programs used by airlines and credit card companies), under which customers are awarded points that may be accumulated for future redemption, would appear to exemplify the type of coupon programs eligible for the favorable treatment of Regs. Sec. 1.451-4.

With Sales

The IRS has denied taxpayers the benefits of Regs. Sec. 1.451-4 on the grounds that the "with sales" requirement was not met. In Capital One Financial Corp., 133 T.C. 136 (2009), aff'd, 659 F.3d 316 (4th Cir. 2011), the Tax Court determined that the taxpayer (Capital One) was a buyer, rather than a seller, in the transaction. Capital One issued points toward the purchase of an airline ticket for each dollar charged on a Capital One credit card. The Tax Court denied Capital One the benefit of Regs. Sec. 1.451-4, noting that although a sale had occurred between the cardholder and the merchant, Capital One's role in the transaction was that of a buyer (having purchased a note receivable).

In Rev. Rul. 74-69, the IRS denied the benefits of Regs. Sec. 1.451-4 to a...