Tax planning for gift certificates, layaways and store credits.

• Author: Abahoonie, Edward J.

During the holiday season many retailers saw an increase in sales of gift certificates and layaways. These "advance payments" are often received in one fiscal year, with final sales or redemptions not occurring until a subsequent year. In addition, some retailers will issue store "credits" (in lieu of cash refunds) for returned merchandise. Attention should be given to the tax opportunities that exist to defer income recognition and sales tax on these transactions to a later year.

For income tax purposes, these cash receipts generally must be reported no later than when they are reported as income in the company's financial statements. Reporting these receipts as sales in the financials prior to actual fulfillment produces the worst tax results from a cash flow standpoint. It causes the full amount of the cash payments, with no deduction or reserve for the cost of goods, to be taxable. This rule applies even though there may be certificates, deposits or store credits that go unredeemed or unapplied for many years. In addition, many states require that sales tax be reported and paid for the period in which the sale is reported on the books.

Companies that treat receipts as deposits (i.e., as liabilities for financial statement purposes) can defer reporting taxable income for up to two years. In addition, if advance payments remain unfulfilled after two years, the company may be allowed a deduction for estimated cost of goods sold at that time. This income tax deferral is available both to companies whose financial accounting method is already in place as well as to those willing to change. Those companies wishing to change their financial statement reporting in order to obtain the tax benefits should apply for an appropriate letter ruling from the Service to ensure the result. An IRS ruling...