Favorable guidance issued on deferral of gift card sales and gift cards issued for returned goods.

• Author: Chou, Yuan

The popularity of gift cards and gift certificates (collectively referred to as gift cards) has increased dramatically in recent years. For state escheat and unclaimed property reasons, a common business model is for gift cards to be sold and managed by a separate gift card company (Giftco) and redeemed by either an affiliated party or an unrelated third party under a gift card service agreement. Since 2007, the IRS has taken a position in informal guidance that deferral is not permitted under either Rev. Proc. 2004-34 or Regs. Sec. 1.451-5 in situations where the entity selling the gift card is not the one ultimately providing the goods or services in redemption of the gift card. Controversy has also arisen relating to the tax treatment of gift cards issued for returns of merchandise.

On January 5, 2011, the IRS issued two taxpayer-favorable revenue procedures addressing the treatment of payments received for gift cards. The first (Rev. Proc. 2011-17) provides a safe-harbor method of accounting for gift cards issued in exchange for returned merchandise, while the second (Rev. Proc. 2011-18) involves income deferral for gift cards that can be redeemed by a third party.

Background

For tax purposes, amounts received by an accrual-method taxpayer for goods or services it will provide in the future must generally be included in gross income in the tax year of receipt. However, deferral is permitted under either Regs. Sec. 1.451-5 or Rev. Proc. 2004-34. Regs. Sec. 1.451-5 generally allows accrual-method taxpayers to defer recognition of the advance payment for goods until the tax year that the payments are recognized in revenues under the taxpayer's method of accounting for financial reporting purposes. However, Regs. Sec. 1.451-5(c) provides that a taxpayer generally may not defer advance payments for inventoriable goods beyond the end of the second tax year following the year the taxpayer receives a substantial advance payment such as a gift card sale (hence, a two-year deferral).

The second exception, Rev. Proc. 2004-34, is broader but provides a shorter deferral period. Under this revenue procedure, an accrual-method taxpayer may defer all or part of certain advance payments for services and/or the sale of goods in gross income until the tax year following the tax year in which payment is received (hence, a one-year deferral).

Rev. Proc. 2011-17

Rev. Proc. 2011-17 provides a safe-harbor method of accounting for the treatment of gift cards...