Restaurants, retailers and other companies selling gift cards that are redeemable for either goods or services may be able to extend the deferral period for recognizing those sales as income for federal tax purposes.
Companies either immediately recognizing gift card sales as income or deferring recognition until the following year should review their treatment of gift card income in light of recent IRS guidance.
The Gift Card Industry
According to industry estimates, gift card spending is projected to be approximately $140 billion in 2016. The gift card industry is expected to continue to grow significantly over the next several years as gift cards are one of the most requested gifts.
In a typical gift card transaction, a retailer or service provider receives an advance payment from a customer in exchange for an obligation to provide goods, services, or a mix thereof, when the gift card is ultimately redeemed at some point in the future. For example, retailers may sell gift cards that are redeemable for both goods and services.
Integral services to the sale of a good include repair, installation and delivery of the goods. Non-integral services are ancillary to the provision of goods. In the restaurant and hospitality industry, gift cards are often issued for future services (e.g. meals, merchandise sold on-site or online).
Gift Card Taxable Income
Under generally accepted accounting principles (GAAP), the income from the sale of the gift card is generally deferred until the date the gift card is redeemed. On the other hand, income is generally recognized when received for income tax purposes unless certain exceptions apply. One of these exceptions applies to gift cards.
Under current tax rules, the portion of an advance payment attributable to the sale of goods or services is not includible into income until the year of its inclusion in income for GAAP purposes or the second year following the year of receipt of the advance payment (the “two-year deferral”). This two-year deferral period is also applicable to services that are integral to the sale of the goods or services that are considered de minimis (too small to account for) because they comprise less than five percent of the total contract price. Gift card income attributable to non-integral services may be eligible for deferment until the following year (“one-year deferral”).
IRS Gift Card Tax Guidance
Recent IRS guidance requires that taxpayers use a reasonable method to estimate the amount of outstanding gift cards at year-end that are allocable to the sale of goods or integral services and non-integral services.
Reasonable allocation methods presumably include the use of historical data regarding the redemption of gift cards or a breakdown of sales between goods, integral services, non-integral services, and de minimis services. The amount reasonably allocated to the future sales of goods, integral services, or de minimis services would be eligible for the two-deferral period.
Many companies that sell gift cards use the one-year deferral method as the default method. Many companies also incorrectly assume that the two-year deferral method is only available for gift cards attributable to the sale of goods.
Form 3115, Application for Change in Accounting Method, is required to be filed for any taxpayers that would like to change their method of accounting for gift cards.
SLD CPAs Can Help with Gift Card Deferral Policies
Shea Labagh Dobberstein has assisted businesses in the Bay Area for over 70 years.
If you’re in need of a certified public accountant to assist your business in matters relating to gift card income tax, SLD has the experience you can trust. Whether you’re an existing client or a new client, we’re here to help with exceptional service.
- San Francisco: (415) 397-4444
- San Mateo: (650) 579-7200