The Internal Revenue Service recently confirmed its position that income from the sale of gift cards is taxable in the year of receipt for a gift card issuer that uses the accrual method of accounting.
In Technical Advice Memorandum 200849015 (advice given by the national office of the IRS to an IRS agent in connection with an audit, applying the tax law to a specific set of facts), an accrual basis taxpayer sold gift cards to the general public for cash. The taxpayer had agreements with retailers to sell and reload the taxpayer's gift cards and remit all of the proceeds to the taxpayer. The retailers also agreed to redeem the gift cards for goods and services from their respective stores. After the gift cards were redeemed, the taxpayer paid the retailers an amount equal to the amount of the redeemed gift cards. Only the taxpayer had any liability to the purchasers of the gift cards. Under the retailers' business practices, however, gift card holders could receive cash refunds for card balances or returns below a certain threshold. Returns in excess of that amount merely increased the balance on the purchaser's gift card.
On these facts, the IRS ruled that the taxpayer recognized taxable income in the year a gift card is sold in an amount equal to the receipts from such sale. From the time of the receipt of the proceeds, the taxpayer had complete dominion and control over the proceeds. The taxpayer's liability to make payments (either to the retailers or to the purchaser) was totally contingent. Unless and until a subsequent event occurred that required the taxpayer to pay the retailer or the customer, the taxpayer could use the proceeds for any purpose.
The IRS also ruled that the taxpayer did not qualify for any income deferral mechanism since the taxpayer was not engaged in the sale of goods to customers. The taxpayer never took title to the goods, even for an instant, and the taxpayer did not hold itself out to customers as a seller of goods. In addition, the IRS denied the taxpayer's claim for an offsetting deduction for the corresponding liabilities since liabilities of an accrual basis taxpayer cannot be deducted before the liability becomes fixed, which in this case does not occur until the gift card is redeemed.
Although a Technical Advice Memorandum issued with respect to one taxpayer is not binding on other taxpayers, taxpayers generally pay attention to these Memoranda as providing guidance as to how the IRS would decide an issue. Some courts have also cited Technical Advice Memoranda in their decisions.
The IRS has also increased its audits of gift card programs.