Retailers and other companies selling gift cards redeemable for either goods or services may be entitled to extend the period over which they defer recognizing taxable income from those sales. Retailers currently recognizing all gift card sales either immediately upon receipt or in the following tax year need to review their current accounting practices for gift cards in light of a recent IRS interpretation of the applicable rules.
Generally, accrual method taxpayers must include in taxable income “advance payments” such as gift card sales in the year of receipt. Rev. Proc. 2004-34 allows the portion of an advance payment not recognized for financial accounting purposes in the year of receipt to be deferred until the following year. A longer deferral period—up to an additional year—is available under Reg. section 1.451-5 for advance payments for the sale of goods, including the sale of gift cards.
The IRS National Office recently clarified in a technical advice memorandum (TAM 201610017) that the longer two-year deferral period is available in situations in which the consumer has the option to redeem the gift card for goods—even if the gift card also may be redeemed for “non-integral” services. For example, if a retailer sells a gift card that may be redeemed for either merchandise or for automotive repair services, the extended two-year deferral period may be available for at least a portion of the sales proceeds.
Under the IRS’s recent interpretation of Reg. section 1.451-5, the retailer aggregates all gift cards outstanding at the end of the tax year of the cards’ sale into a single pool and allocates that pool between the portion reasonably expected to be redeemed for merchandise and the portion reasonably expected to be redeemed for other purposes. The amount reasonably allocable to future merchandise sales would be eligible for the extended two-year deferral period.
Read text of TAM 201610017 [PDF 107 KB] (release date March 4, 2016, and dated August 28, 2015).
Some retailers have assumed that they are not eligible to use the two-year deferral period if a customer can redeem a gift card for either merchandise or for services. As a consequence, many retailers currently defer all gift card sales for at most a single year under Rev. Proc. 2004-34. In light of the IRS’s clarification of the availability of the two-year deferral period, retailers need to review their current accounting practices for gift card sales for potential eligibility to defer recognizing income from the sale of gift cards for an additional year.
The tax benefits available through the longer deferral are obtained by filing a Form 3115, Application for Change in Accounting Method, with the IRS National Office under the advance-consent accounting method change procedures. Upon receiving IRS consent, the retailer will recognize the resulting tax benefit entirely in the year of change through a section 481 adjustment.
KPMG’s Accounting Methods and Credit Services (AMCS) practice has professionals with a deep knowledge of both the retail industry as well as the deferral rules applicable to gift card sales. An AMCS team member in your area is available to help identify situations in which an additional deferral may be available, develop an accurate allocation methodology, determine the benefit to be captured by changing the company’s present method of accounting for gift card sales, and efficiently secure consent for and implement the required accounting method changes.
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