Deferral of income from sale of gift cards.

• Author: Brown, Mark

In recent years, retailers have experienced a significant increase in the sale of gift cards, which have become a large percentage of total sales. With retailers receiving advance payments in increasing quantities, the issue of when this income should be reported for federal tax purposes has become more prominent. Over the past several years, the IRS has issued guidance on the treatment of advance payments. However, the complexity of gift card transactions has increased as well. The IRS has once again stepped in to provide additional clarification. This item summarizes the recently released Rev. Proc. 2011-18, which provides guidance on the deferral of income from the sale of gift cards.

Income Tax Recognition of Advance Payments

Generally, under Sec. 451(a), "[t]he amount of any item of gross income shall be included in the gross income for the taxable year in which received by the taxpayer, unless, under the method of accounting used in computing taxable income, such amount is to be properly accounted for as of a different period." Under the accrual method of accounting, income is includible in gross income when all the events fixing a taxpayer's right to receive it have transpired. The all-events test is met when (1) the payment is earned through performance, (2) payment is due to the taxpayer, or (3) payment is received by the taxpayer, whichever happens earliest. Therefore, advance payments received by an accrual-method taxpayer generally are included in gross income in the year of receipt.

However, their recognition may be deferred in certain situations. Regs. Sec. 1.451-5 defines advance payments to include any amounts received in a tax year by an accrual-method taxpayer for purchases and sales, pursuant to an agreement for the sale or other disposition in a future tax year of goods held by the taxpayer for sale to customers in the ordinary course of the taxpayer's trade or business. The regulation provides that the term "agreement" includes gift cards that are redeemable for goods (Regs. Sec. 1.451-5(a)(2)(i)). Such advance payments must be included in income in either the year of receipt or the tax year that the revenue is recognized under the taxpayer's method of accounting for financial statement purposes (Regs. Sec. 1.451-5(b)(t)).

Regs. Sec. 1.451-5(c) provides that for agreements for the sale of goods properly includible in the taxpayer's inventory,

all advance payments received with respect to such agreement by the last day...