Gift card and gift certificate income deferral.

• Author: Suttora, John

This item analyzes IRS audit guidelines for the treatment of gift card and gift certificate income, focusing on situations that require an examining agent to raise issues with IRS industry technical advisers. On May 23, 2007, the IRS issued Industry Director Directive LMSB-04-0507-039, a guide to when an agent should raise an issue in examinations of taxpayers in the retail, food, and beverage industries who are receiving gift card or gift certificate income. According to the directive, the IRS has identified inconsistent tax accounting treatment within the industries for the recognition of revenue and expenses related to gift cards and gift certificates, and the "variations and problems are numerous."

Revenue Recognition Deferral

The directive notes that the use of gift cards has increased significantly. Revenue from sales of gift cards is not immediately recognized for financial reporting purposes and may also be deferred for tax purposes under the regulations or a revenue procedure. Regs. Sec. 1.451-5 allows deferral for advance payments for goods (including unredeemed gift card or gift certificate income) up to the end of the second tax year following the year of sale (although the deferral cannot be greater than it is for financial accounting purposes, and the taxpayer must have sufficient goods on hand to satisfy the outstanding gift cards or gift certificates).

Rev. Proc. 2004-34 allows taxpayers to elect a deferral method for advance payments for goods or services, or both (including unredeemed gift card or gift certificate income), up to the end of the tax year following the year of sale in certain circumstances (although the deferral cannot be greater than it is for financial accounting purposes) (Rev. Proc. 2004-34, [section][section] 5.02 and 5.03,Examples 7 and 8).

Gift Card Issues

The directive segregates the gift card and gift certificate "variations and problems" into two categories--Part A and Part B. Part B issues, for which no examination planning or procedural guidance is provided, include separate gift card companies, gift card versus gift certificate, reloadable gift cards, deposits, gift cards as refunds, dormancy fees, escheatment to states, bulk sales discounts, promotional gift cards (advertising), charitable contribution of gift cards, estimated cost of goods sold, franchise/franchisor gift cards, expiration date, and Rev. Proc. 2004-34. Part A issues, which an examining agent must raise with the IRS's industry...