Deferral of Advance Payments from Gift Card Sales

The sale of gift cards and gift certificates is a widespread business practice in many industries. In the past, sales of gift cards were recognized as income in the year of sale if the gift cards were redeemable by an unrelated entity. This practice was problematic because if the gift card was never redeemed, or was used in a later year, the income was not earned in the year of sale. Instead, the sale was actually an advanced payment for goods or services.

Under the deferral method of accounting, an accrual-basis taxpayer that receives an advance payment for goods or services must include the payment in gross income in the year of receipt to the extent recognized in revenue on an applicable financial statement (AFS). If an AFS isn’t filed, the advance payment is included in income to the extent earned in that year. This income deferral was available only for gift card transactions between related entities.

However, IRS guidance issued in Rev. Proc. 2013-29 allows the deferral of advance payments from the sale of gift cards (or gift certificates) that are redeemable for goods or services by an unrelated entity. Under this guidance, the seller of the gift card is liable to the customer (or holder of the gift card) for the value of the card until it is redeemed or expires. If an unrelated entity is legally obligated to the seller to accept the gift card from a customer as payment and the unrelated entity’s financial results are not included in the seller’s AFS, the payment is recognized as revenue by the seller in its own AFS to the extent that the gift card is redeemed by the unrelated entity. If the seller does not file an AFS, the payment is included in income to the extent earned in that year. The guidance is retroactively effective for tax years ending on or after December 31, 2010, which may provide an opportunity to amend prior years’ returns to claim a refund.

If you have any questions regarding the IRS guidance, or would like help in implementing the deferral method of accounting for gift cards, please call our office at your earliest convenience.