If you’re a franchisor that offers gift cards, you know the value they provide as a promotional tool. But they also add complexity to your accounting and tax reporting. When franchisees sell gift cards, they send you the money, which you’ll use to reimburse them as the cards are redeemed. As the franchisor administering the gift card program, you might never recognize revenue in your financial statements for gift card redemptions, but the tax rules state that these are revenue of the franchisor and, in some cases, may be taxable even before they’re redeemed. What are your options?
If you’re an accrual-basis taxpayer, you have two options for recognizing gift card income on your taxes:
- “Recognized upon receipt” (income is recognized when the cash is received for the gift card purchases): This is known as the “full inclusion method” and is the default method for tax reporting.
- “Deferral until subsequent year:” If certain requirements are met, it may be possible to defer tax under Code Section 451(c) and Reg. Section 1.451-8.
Let’s say you collected $100 from the sale of gift cards in 2023 and $20 was redeemed by the end of the year. By default, $100 would be recognized (using the full inclusion method) as income for tax purposes. However, you may be able to defer some of the taxable income for one year if you meet the following eligibility criteria in Reg. Sec. 1.451-8:
- You’re an accrual-basis taxpayer and gift card income is also deferred for financial statement purposes.
- The gift card is redeemable for goods and/or services (subject to certain exclusions such as rent and insurance premiums, etc.).
- You have a good tracking system in place to track gift card revenue and redemptions.
In our example, if you meet the eligibility criteria, you may be eligible for a one-year tax deferral on the remaining $80 of unredeemed gift cards in 2023. Then, under the deferral method, the full remaining amount of $80 would need to be reported for tax purposes in 2024 — regardless of the remaining $80 in gift cards is fully or partially redeemed. So even though you may not have reported any income for financial statement purposes in 2024 for these gift cards, the full remaining amount of the sale from year one — $80 — would be taxable.
The deferral method was initially limited to taxpayers with applicable financial statements (generally defined as audited financial statements). However, guidance under Regs. Sec. 1.451-8 also allows accrual taxpayers who don’t have an audited financial statement to use the one-year deferral method.
Be mindful that there’s a key difference in how the rules apply to taxpayers with and without audited financial statements. It arises in the determination of an advance payment and the timing of recognition. Any payment that’s not recognized in income in year one under both of these scenarios can be deferred to the subsequent year.
Contact your tax advisor to review your situation and determine eligibility for tax deferral on gift card sales. And to understand how escheat laws may impact your business, contact your legal counsel.
