Treatment of gift card/certificate sales: no answers, more questions.

• Author: Shevak, Richard

Gift card sales are becoming more and more a part of our retail shopping experience. The IRS is aware that the popularity of gift cards has increased "at a remarkable rate in recent years" (LMSB-04-0507-039).

Gift card sales raise a variety of interesting federal income tax questions. The answers to these questions may depend on who is selling the gift card and for whom. For example, certain federal income tax issues arise with the use of gift card managing subsidiaries (gift card companies, described in more detail below) to sell gift cards and also with the sale of cross-redeemable gift cards.

The IRS announced that it plans to focus more on this area. Given the level of gift card sales and the surrounding tax issues, one might think that the IRS would have resolved some of the questions. But as of the writing of this item, the IRS has not yet provided answers--only more questions.

This item highlights certain issues raised by a recent IRS Large and Mid-Size Business (LMSB) Division directive dated October 3, 2008, about the treatment of revenue from the sale of gift cards (IDD No. 2). Before discussing IDD No. 2, however, this item discusses a March 26, 2007, field attorney advice (FAA) (released July 11, 2008) discussing the proper treatment of gift card sales and a prior LMSB directive (IDD No. 1) discussing gift cards dated May 23, 2007.

Proper Treatment of Gift Card Sales by a Gift Card Company

FAA 20082801F addressed several revenue recognition issues that arise in connection with the sale of gift cards by a gift card company. The company described in the FAA was a separate wholly owned subsidiary of the taxpayer and did not have any inventory of its own. The FAA addressed specifically:

1. Whether the gift card company had income from the sale of gift cards;

2. When proceeds from the sale of gift cards were to be included in income; and

3. When the gift card company could take a deduction in connection with the redemption of gift cards.

The FAA first discussed whether the money received by the gift card company constituted income to that company. The FAA stated that the gift card company received the money under claim of right and therefore had income from the sale of gift cards. The FAA held that the amounts received by the company were not in the nature of a deposit because such amounts were not generally refundable to either the retail stores or the customers who purchased the gift cards. The FAA stated that the gift card company...