Newsletter

January 7, 2011 - Retailers Win Victory on When Gift Card Income is Taxable

The Internal Revenue Service gave retailers a major victory on gift cards this week, saying income from sales of the cards doesn’t have to be counted as taxable income for up to a year even if they were sold through a subsidiary or franchise. The IRS also said retailers can treat the issuance of gift cards for returned merchandise as the payment of a cash refund followed by the sale of a gift card.

New guidance issued by the IRS amounts to an update of 1970s regulations that said income from gift cards could be deferred as long as the cards were redeemable with merchandise from the company that sold them.

Disputes have arisen in the past few years, however, because most retailers have set up subsidiaries to handle gift cards. If a card is sold by a subsidiary, but redeemed by another division of the company, the IRS has contended that the income is taxable at the time the card is sold. The agency has audited an increasing number of retailers who have deferred the income.

NRF has argued that the income from gift cards still goes to the same company regardless of whether the cards are sold directly by the parent or through a subsidiary, and asked in 2009 that the income be allowed to be deferred either way.

In a decision released on Wednesday, the IRS agreed, conceding “the manner in which retailers market, sell to customers, and redeem gift cards has evolved over time.”

Whether gift card income is deferred is a moot point if a card is redeemed in the same year it is issued. But deferral can be a significant factor in a retailer’s tax liability when a card is sold one year and not redeemed until the next year, as often happens around the December holiday season.

“This marks a major victory,” NRF Vice President and Tax Counsel Rachelle Bernstein said, noting that members of the NRF Taxation Committee and gift card task force had worked together to prepare submissions to the IRS on the issue.

The IRS said gift card income can be deferred regardless of whether the cards are redeemed by the parent company, a subsidiary or a franchise. In a separate decision, the IRS said income associated with cards issued as a refund on returned merchandise can also be deferred. NRF requested that the national office of the IRS and Treasury provide clarification in both of these areas. The guidance that was subsequently issued removes an issue that the IRS has been challenging on audits of all retailers.

© 2011 National Retail Federation