Advance payments from gift cards may be eligible for longer deferral

The IRS recently issued a technical advice memorandum (TAM 201610017) advising that taxpayers can potentially defer recognition of the portion of advanced payments related to goods from the sale of unredeemed gift cards for two years under Treas. Reg. Sec. 1.451-5 even if some other portion of payments may relate to “non-integral” services. This applies as long as taxpayers can reasonably allocate the amount allocable to goods.

Generally, accrual method taxpayers must include advanced payments from gift card sales in the year of receipt. However, Treas. Reg. Sec. 1.451-5 allows for a two-year deferral for advance payments related to the sale of goods when the payments are not recognized for financial accounting purposes, even if the payment is made for gift cards. However, this longer deferral period would not apply to an amount allocable to non-integral services, because this is not covered under Treas. Reg. Sec. 1.451-5, and instead, could be included in gross income under Section 451(a).

In the TAM, the taxpayer was a large retailer selling products — as well as delivery, installation, repair and other services that weren’t necessarily connected to its own products — out of its retail store. The taxpayer also sold gift cards. The bearer of a gift card could choose when and which items — either goods, services or a combination thereof — could be redeemed by using the card. As such, the IRS said, an amount cannot be properly allocated to the provision of goods under the language of Treas. Reg. Sec. 1.451-5(a)(3) as of the end of the year, because it is unknown what the card will be redeemed for.  

However, the IRS also reasoned that the totality of the taxpayer’s outstanding gift cards should be considered as a single agreement. In that case a process similar to the one in Treas. Reg. Sec. 1.451-5(a)(3) for estimating amounts properly allocable to the sale of goods and integral services and the amount not allocable for these gift cards representing a future sale can apply when the gift card has not been redeemed. No estimation methodology was proposed.

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