Many restaurants sell gift cards that can be redeemed for meals or for merchandise. For tax purposes, these sales are considered “advance payments,” which generally are included in taxable income when they are received. But there may be an opportunity to defer some or all of this income into the following tax year.
Are you eligible?
To determine whether your restaurant is eligible to defer gift card income, the first question you must ask is whether you use the cash or accrual method of accounting. Cash-basis businesses must include gift card sales in income in the year received, regardless of when the cards are redeemed. Accrual-basis businesses, however, may elect a limited deferral (to the following tax year) of certain gift card income.
How does it work?
The Tax Cuts and Jobs Act of 2017 (TCJA) added a provision to the tax code essentially adopting long-standing IRS guidelines on the treatment of advance payments. Those guidelines permit accrual-basis businesses to defer income from the sale of gift cards to the following year, to the extent the cards are not redeemed in the current year, provided such income is deferred beyond the current year on an “applicable financial statement” (AFS). Generally, an AFS means an audited financial statement. (Note: Previously, a two-year deferral was available for the unredeemed portion of gift cards redeemable for certain merchandise, but this option was eliminated by the TCJA.)
What if you do not have an AFS? Although not addressed by the TCJA, the IRS recently issued proposed regulations that generally follow its previous guidance in this area. Under that guidance, businesses without an AFS can defer gift card income to the extent it is not “earned” in the current year. Generally, gift card income is earned when the card is redeemed. Thus, to take advantage of the benefits of tax deferral, you will need a reliable system for tracking gift card sales and redemptions, a key part of a successful program. However, if your volume of gift card sales is so significant that tracking individual card activity would be impracticable, it may be possible to use statistical methods to estimate when income is earned. This is an option only if adequate data is available about the percentage of gift card amounts redeemed in the year sold, redeemed after the year sold and never redeemed.
Other factors need to be considered, such as determining when (and whether) gift card income is earned, you should also consider the potential impact of state unclaimed property laws, which may require you to turn over certain unredeemed gift card values to the state. As one would expect, these laws vary dramatically from state to state. Some states require you to turn over the value of unredeemed gift cards after a specified amount of time. Others treat gift cards as unclaimed property only if they have an expiration date. And some states exempt gift cards from their unclaimed property laws. You will need a system for addressing these rules in your accounting policies and assessing their impact on revenue recognition and tax liability.
Is it worth the effort?
To determine whether deferring gift card income is a worthwhile strategy, it is important to weigh the potential tax benefits against the cost of tracking gift card activity. Unless your gift card sales are large enough that deferral will generate significant tax savings, you may be better off simply including these sales in taxable income when received and avoiding the expense of a sophisticated tracking system.
For more information about the tax and accounting treatment of gift cards, please contact Chris Georgiou at [email protected] or call him at 312.670.7444. Visit ORBA.com to learn more about our Restaurant Group.