The IRS in recent guidance clarified the application of the advance payment income deferral rules to the sale of gift cards redeemable for either goods or services. The clarification was welcomed as different deferral periods apply to gift cards depending on whether they are redeemable for goods or for services. Taxpayers universally applying the more conservative deferral rules applicable to gift cards redeemable for services may have an opportunity to obtain an additional year of deferral on unredeemed gift card revenue properly allocable to the redemption for goods.

Generally, taxpayers using the accrual method of accounting may adopt an accounting method to defer recognition of income from the sale of gift cards that are unredeemed as of year end. If a gift card is redeemable to purchase goods, the gift card revenue must be recognized as of the earlier of:

• The year in which the gift card is redeemed,
• The year in which the gift card revenue is recognized for financial statement purposes, or
• Two years after the year in which the gift card was sold.

The two-year deferral period applies not only to gift cards redeemable for goods, but also for services that are integral to the sale of goods and to services that are deemed de minimis because they comprise less than five percent of the total contract price.

Revenue from the sale of gift cards redeemable for non-integral services can be deferred under similar rules as above, but only for one year after the year in which the gift card was sold.

In TAM 201610017, the IRS addressed a situation where the taxpayer sold gift cards that could be redeemed for goods, integral services or non-integral services. Of course, the taxpayer would not know until redemption whether the gift card was being redeemed for goods and integral services or for non-integral services. As a result, how would the taxpayer know whether to apply the one-year or two-year deferral rule to the unredeemed gift card balance? Or, does the fact that the gift card could be redeemed for non-integral services restrict the taxpayer to using the one-year deferral?

In the ruling, the IRS concluded that the taxpayer could use a reasonable method to estimate the amount of unredeemed gift card revenue allocable to the sale of goods or integral services (eligible for the two-year deferral) and non-integral services (while not explicitly stated in the ruling, presumably eligible for the one-year deferral). Whether the method of estimation is reasonable is a question of fact, and no proposed estimation methodology was contemplated in the ruling. Presumably, historical data establishing the allocation of sales between goods and services could be used to estimate the allocation of the gift card revenue, especially if the taxpayer can establish that customers generally buy the same proportion of goods and services with gift cards as they do with cash or credit cards.

Taxpayers that desire to either adopt the two-year deferral of unredeemed gift card revenue or change the methodology to allocate gift card revenue between goods and services may request an accounting method change under the non-automatic change procedures. A non-automatic change is requested by filing with the IRS Form 3115, Application for Change in Accounting Method, during the year in which the method will first be used and paying the applicable user fee.

If your company sells and redeems gift cards, contact your local CBIZ MHM tax professional to discuss the implications of this new ruling.

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