IRS continues to challenge deferral of revenue from gift cards.

• Author: Fitzpatrick, Cathy

In recent years, due to the increasing use of gift cards and the disparity between the federal tax accounting and financial accounting treatment of advance payments, there has been inconsistency among taxpayers and confusion as to the proper timing of recognizing income from gift cards. One specific issue that has arisen is the treatment of gift card income when a taxpayer maintains a separate gift card company that is responsible for selling the cards and operating the gift card program for it and other related entities but does not itself sell or provide the goods for which the cards can be used. The IRS recently addressed this issue in Technical Advice Memorandum (TAM) 200849015.

Summary of TAM 200849015

In the TAM, Taxpayer, a C corporation, uses the overall accrual method and is a subsidiary of Parent and part of Parent's consolidated group. Parent formed Taxpayer to manage Parent's gift card program and oversee the entire gift card program for the Parent consolidated group in exchange for a management fee. Taxpayer issues and sells all gift cards used in stores operated by Parent and related entities and in certain stores operated by an unrelated entity. The gift cards can be redeemed for goods (or limited services integral to those goods) from retailers operated by other taxpayers within the consolidated group (the retailers) and from the unrelated entity.

Under the gift card program agreement, the retailers agree to sell and reload Taxpayer's gift cards in their stores, remit all amounts paid to Taxpayer, and redeem the cards in exchange for merchandise. After the cards are redeemed, Taxpayer pays the retailers amounts equal to the amounts of the redeemed cards. Taxpayer is solely liable and obligated to the purchasers and holders of the gift cards--except the retailers are liable to Taxpayer to accept the balance on a gift card as payment for goods and services. Under the retailers' business practices, gift card holders can receive cash refunds for card balances under a certain amount. If a cardholder returns a purchase made with a gift card, the retailer will increase the balance on the gift card by the amount of the return; however, for returns below a certain amount the retailer will issue a cash refund.

The TAM addresses three issues related to the amounts received by Taxpayer on its sale of the gift cards (gift card receipts):

1. Are the gift card receipts includible in Taxpayer's gross income (i.e., are they considered income or deposits)?

2. Are the gift card receipts "advance payments" within the meaning of either Regs. Sec. 1.451-5 or Rev. Proc. 2004-34 (and therefore eligible for deferral)?

3. If the gift card receipts are includible in income upon receipt, may the Taxpayer take an immediate deduction for the liability to pay the amount to a retailer?

Income or deposits: The TAM concludes that the gift card receipts are payments over which...