In technical advice (TAM 201610017), the Service has ruled that a company may defer income from the sale of unredeemed gift cards under Reg. Section 1.451-5 to the extent it can appropriately estimate the amounts that are deferrable using an allocation similar to the one found in Reg. Section 1.451-5(a)(3).

Facts

A multinational e-commerce and physical retailer sells certain products and offers various related services, including delivery, installation and repair of the products. The company also sells services that are not related to its core business. For example, a customer may purchase repair services for a product not purchased from the company. Additionally, the company sells warranty or service plans on behalf of a third party.

The company also sells gift cards that do not have an expiration date and may be used to purchase goods, services or a combination of goods and services. The gift cards are activated and are available for immediate use at the time of purchase.

The gift cards have the same stock keeping unit, which allows the company to track when the gift cards are purchased. A third party tracks the gift card balances and redemption data electronically.

The company determines its breakage rate, which is the amount of gift cards never redeemed, using historical redemption patterns. For gift cards issued in Year 1, the company recognized breakage income in Year 4 and, for gift cards issued in Year 2, the company recognized breakage income in Year 5.

Law and analysis

Reg. Section 1.451-5(a)(1) defines "advance payment" as any amount that is received in a tax year pursuant to and to be applied against an agreement for the sale or other disposition in a future tax year of goods held by a taxpayer for sale to customers.

The Service concluded that the term "agreement" as defined in Reg. Section 1.451-5(a)(2)(i) includes gift cards that are redeemable for goods and other items. The Service also determined that the amounts received for the gift cards are applied against the agreement because the amounts are used to make purchases in future tax years.

Additionally, the Service concluded that Reg. Section 1.451-5(a)(3) is not applicable to the company's individual gift cards because the gift cards may be redeemed for goods and services and what the gift cards will be redeemed for is unknown. Therefore, a proper allocation between goods and services cannot be made. Reg. Section 1.451-5(a)(3) provides that if a taxpayer receives an amount under an agreement requiring it to provide goods and non-integral services, that amount will be treated as an advance payment only to the extent the amount is properly allocable to the obligation to provide goods. A de minimis rule applies to amounts that aren't allocable. If a company's gift card is outstanding at the end of the tax year in which it is purchased, however, an amount can't be properly allocated because what the card will be redeemed for is unknown.

The Service, however, also ruled that gift cards that can be redeemed for goods and non-integral services are eligible to apply allocation rules similar to those in Reg. Section 1.451-5(a)(3) by treating all of the company's outstanding gift cards at the end of the tax year of their sale as a single agreement and allowing estimates to be used for the application of Reg. Section 1.451-5(a)(3). Thus, the company may defer amounts received for its gift cards to the extent it can make an appropriate estimate of the amounts that are deferrable under Reg. Section 1.451-5. The IRS noted that whether the company's estimation methods are appropriate is a question of fact to be determined by the field.

Implications

This TAM demonstrates the IRS's increasing flexibility in permitting income deferral in the gift card context. By applying this approach, the taxpayer is eligible to defer amounts received for its gift cards to the extent it can make an appropriate estimate of the amounts that are deferrable under Reg. Section 1.451-5. The IRS noted that whether the company's estimation methods are appropriate is a question of fact to be determined by the field.