New Rules for Tax Treatment of Gift Cards

Do you have a policy of issuing gift cards to customers in exchange for returned merchandise?  If so, this post is for you. For income tax purposes, generally, payments received by an accrual method for a gift card or gift certificate (advance payments) must be included in gross income in the tax year of receipt.  However, there are two exceptions to this general rule found in Treas. Reg. § 1.451-5 and Rev. Proc. 2004-34.

On January 5, 2011, the Internal Revenue Service issued Rev. Proc. 2011-17 and Rev. Proc. 2011-18 related to the deferral of income involving gift cards for taxable years ending on or after December 31, 2010 and the administrative steps that would need to be taken to obtain consent on a change in accounting methods.   The new revenue procedures bring parity to the treatment of cash refunds and gift cards issued for returned merchandise.

Rev. Proc. 2011-17 provides a safe harbor in which a retailer may treat the issuance of gift cards in exchange of goods in one of two ways: (1) as the payment of a cash refund in the amount of the gift card or (2) the sale of a gift card in the amount of the gift card.  Thus, the retailer may account for the amount deemed received for the sale of the gift card under Treas. Reg. § 1.451-5 or Rev. Proc. 2004-34, if otherwise eligible.

The Service acknowledges several types of gift card arrangements in Rev. Proc. 2011-18, including a retailer that sells gift cards redeemable through a third party.  The criteria for an “eligible gift card sale” is met if: (1) the taxpayer is primarily liable to the customer, or holder of the gift card, for the value of the card until redemption or expiration; and (2) the gift card is redeemable by the taxpayer or by any other entity that is legally obligated to the taxpayer to accept the gift card from a customer as payment for goods or services.

A change in the tax treatment of gift cards issued as a refund for returned goods to the one-year deferral method of Rev. Proc. 2004-34 and the safe harbor is a combined automatic-consent method change, while a change to the two-year deferral of Treas. Reg. § 1.451-5(c) and the safe harbor is a combined advance-consent method change.  Moreover, Rev. Proc. 2011-18 does not modify Treas. Reg. § 1.451-5 to allow deferral of advance payments when the entity issuing the gift card is not the entity redeeming the gift card and therefore, a two-year deferral is not permitted.

These revenue procedures provide necessary guidance to the tax treatment of gift cards, help to reduce controversy, and outline the procedures by which taxpayers may request a change in accounting method.

To ensure compliance with Treasury Department regulations, we wish to inform you that any tax advice that may be contained in this communication (including any links to outside sources) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding tax-related penalties under the Internal Revenue Code or applicable state or local tax law provisions or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein.

Material discussed in this blog post is meant to provide general information and should not be acted upon without first obtaining professional advice appropriately tailored to your individual circumstances.