Do You Know the IRS Rules for Gift Cards?
Who doesn’t like gift cards? For the giver, it’s an easy way to show appreciation, and for the recipient, it can be an excuse to indulge in something extra that you wouldn’t ordinarily buy for yourself. But for businesses who sell them, the accounting gets complex very quickly.
Under U.S. GAAP, businesses can defer the revenue until the card is actually used. But since about $1 billion of the value of gift cards sold in the U.S. each year is never redeemed, liabilities for those unused cards can add up quickly. So GAAP allows businesses to write off those unused gift card balances, also known as breakage. This write-off can be either in proportion to the historic pattern of gift card redemption, or when a card hasn’t been used for a certain period.
Recognition for tax may be accelerated compared to book
However, the tax treatment is different. As you might expect, the IRS prefers that revenue be recognized sooner rather than later so that they can collect the tax on those gift card sales as soon as possible. For companies on the cash basis of accounting, it’s straightforward: gift card revenue is recognized when the cash from the sale of the gift card comes in.
Full recognition = cash basis
But for companies on the accrual method, the IRS gives businesses two choices. The simplest method is full recognition. This puts gift card sales on the cash basis — revenue for all gift cards is recognized in the year they’re sold, whether they’ve been redeemed or not. This is a simple method, particularly if there isn’t a robust system for tracking sales and redemptions.
Deferral is allowed, but not much
The other method is deferral. However, unlike GAAP, the IRS only allows deferral until the end of the year after the card is sold, or in some circumstances, until the end of the second year after the card is sold.
This means that if a business sells gift cards during 2018, when that business files their 2018 tax return, they’ll recognize revenue for all the cards sold and redeemed that year. Under a one-year deferral, the remaining balance of 2018 gift cards will be recognized on the 2019 tax return, whether they’ve been redeemed or not.
If the cards will be redeemed for goods, a two-year deferral is allowed. This means that for those gift cards sold in 2018, all remaining revenue must be recognized on the 2020 tax return, regardless of whether they’ve all been redeemed or not.
Robust tracking is a must
Businesses who want to use the deferral method need a robust system for tracking sales and redemptions of cards. Gift card redemptions must be tracked according to the year the card was originally sold.
This also means that gift card revenue on the tax return will be different from the actual redemptions for the year. Many businesses find it simpler to use the full recognition method and recognize the revenue as cards are sold. Changing methods requires filing Form 3115 for a change in accounting method. Form 3115 is also needed if a business hasn’t been using either of the two permissible methods for their gift card sales.
If you need help deciding which method is best for you, or if you want to switch to another method, contact our office, and we’ll be glad to help you out.