Tax accounting: restaurant management company may not defer recognition of income from gift card sales.

• Author: Tull, Cory

The IRS has determined in a legal advice memorandum (20093801F) that a restaurant management company may not defer income recognition from the proceeds of gift card sales under Regs. Sec. 1.451-5 or Rev. Proc. 2004-34.

Facts

The taxpayer is an S corporation and full-service restaurant management company that maintains its books and files its income tax returns on an accrual basis. It has sold gift certificates (now gift cards) for many years. The IRS has audited it on several occasions, but not on the issue of its reliance on Regs. Sec. 1.451-5.

The taxpayer was incorporated in year 1 to succeed in merger to an affiliated group of restaurants. When the IRS began auditing the taxpayer, the taxpayer owned and operated several of the original restaurants, and its affiliates operated several other restaurants, all of which participated in the taxpayer's gift card program. Today the taxpayer owns and operates only one of the original restaurants, and the bulk of its income stems from management fees it charges for services it provides to affiliate-owned restaurants. The taxpayer does not own the affiliated restaurants and has an equity interest in some, but not all, of those restaurants.

The affiliated restaurants are all advertised and promoted under the original brand name, so the "restaurant-brand" gift cards are honored at all participating restaurants, regardless of where the card was purchased. As the management company, the taxpayer has the ability to determine which of the restaurants will participate in its gift card program. If a restaurant closes or its participation in the program is otherwise terminated, the restaurant has no further rights or obligations under the program except for a right to have the taxpayer reimburse it for gift cards honored by the restaurant prior to the termination.

The participating restaurants accept the gift cards, which have no expiration date, like cash. Customers can purchase the cards in person at a participating restaurant, online, via fax or e-mail, or by telephone through the taxpayer's gift card sales department. The participating restaurants remit the proceeds of all gift cards sold to them by the taxpayer, honor the cards when presented, and then present the taxpayer with the cards, which are exchanged for cash. The participating restaurants have no right to proceeds from the sale of gift cards that are not redeemed, and they recognize gift card income only when cards are redeemed at their...