IRS allows estimates to defer advance payments from gift card sales
TAX ALERT |
In a recently released Technical Advice Memorandum (TAM -107447-15), the IRS concludes that a taxpayer can defer for up to two years, the recognition of certain advance payment income from the sale of gift cards for goods or services. To determine the amount eligible for the deferral under Reg. section 1.451-5, a taxpayer may use an appropriate estimate using an allocation similar to the allocation in Reg. section 1.451-5(a)(3).
The TAM reviews a situation where a taxpayer operates a retail store and website and sells merchandise through physical and e-commerce channels. In addition to the goods sold through these channels, the taxpayer offers services such as delivery, installation and repair, related to the goods purchased. The taxpayer also offers services unrelated to the goods purchased (i.e., repair services for goods not purchased from the taxpayer and installation of goods not purchased from the taxpayer).
In its course of business, the taxpayer sells gift cards to customers, which do not have an expiration date and can be purchased up to any amount.The taxpayer does not change fees for the purchase or redemption of the gift cards and the holder of the gift card can use the gift card to purchase goods, services or a combination of goods and services from the taxpayer.
The taxpayer recognizes breakage income from the sale of gift cards for financial statement purposes when it determines the likelihood of redemption is remote. For example, the taxpayer would recognize breakage income in years four and five for gift cards issued in years one and two, respectively.
The sale of gift cards redeemable for a future purchase of goods (or goods and services, where the provision of services is an integral part of such sale) may be considered an advance payment for income tax purposes, dependent on certain criteria described in section 1.451-5. As an advance payment, section 1.451-5(b) provides that a taxpayer generally must include amounts received in income either in the tax year of receipt, or no later than the time the advance payments are included in the earlier of revenue for the taxpayer’s financial statement or the second tax year following the year in which the taxpayer receives substantial advance payments (note this determination also depends on the taxpayer’s method of accounting for federal income tax purposes).
In the instance where the gift card sale could obligate the taxpayer to sell a good or perform a service not an integral part of the sale of the good, the taxpayer can only defer the recognition of revenue to the extent the taxpayer can allocate the revenue to the obligation to sell a good. Generally, a taxpayer cannot determine what amount of the gift card sale will be allocable to the sale of a good (or a service integral to the sale of the good) or to the sale of a service not integral to the sale of a good until the customer redeems the gift card. Since the taxpayer cannot determine the exact allocation at the time of the sale, it generally cannot defer the recognition of revenue for the portion attributed to the sale of goods under section 1.451‑5(a)(3), unless the IRS allows an estimation of the amount.
As the provisions of section 1.451-5(a)(2)(i) provide that an agreement that qualifies as an advance payment includes gift cards that can be redeemed for goods, the IRS concludes a taxpayer may treat the sale of a gift card as a single agreement, and then estimate amounts allocable to the sale of goods, integral services and non-integral services. The TAM also provides that gift cards that can be redeemed for goods and non-integral services are eligible to apply allocation rules by treating the total of the taxpayer’s outstanding gift cards at the end of the taxable year of sale as a single agreement and allowing estimates to be used to apply the allocation required under section 1.451-5(a)(3). This approach allows a taxpayer to defer the amount received for the sale of gift cards to the extent it can make an appropriate estimate of the amounts deferrable for the sale of goods.
This TAM provides taxpayers clarity in applying the deferral of advance payment provisions of the section 451 regulations. While the TAM may not be cited or relied upon for authority, it does provide insight that the IRS may allow a taxpayer to make a reasonable estimation of the amount qualified as an advance payment eligible for deferral under section 1.451-5(a). If a taxpayer believes that it has a similar fact pattern, taxpayers should reach out to their tax advisors to determine whether taxpayers can defer similar gift card sales revenues.