By Giles Sutton, J.D., LL.M, firstname.lastname@example.org
Gift-card sales have surged in recent years. With electronic or virtual gift cards and mobile applications that allow consumers to purchase and redeem gift cards from their mobile/smartphones, sales only continue to grow. While consumers flock to them for their flexibility, businesses have embraced them as a means to increase sales. Not only are buyers spurred into making new purchases, but they often spend more than the gift-card amount.
For retailers, gift cards can also be instrumental to improving cash flow and managing inventory. Perhaps the greatest benefit to retailers is that a sizable number of consumer gift-card purchases are never redeemed. Estimates of the percentage of gift-card balances that remain unredeemed — otherwise known as breakage — range from 10% to 19%. While gift-card breakage has certain accounting and state escheat implications, since it affects income recognition, these unredeemed dollars can have a significant influence on many companies’ bottom lines.
But with the growth in the use of gift cards comes an uptick in scrutiny and regulation, especially within the past year. For consumers, there is increased protection under Title IV of the Credit Card Accountability, Responsibility and Disclosure Act of 2009 (Card Act), which went into effect in early 2010. The Card Act restricts gift card issuers from charging fees on cards for 12 months and extends card expiration until five years after purchase. In addition, the Federal Reserve Board (FRB) and the IRS have recently issued new rules for companies with gift-card programs, providing much-needed guidance.
“Gift cards have become an area of both opportunity and risk for retailers. They have come to provide a critical source of earnings, yet at the same time, the regulatory environment, including tax and financial reporting for gift cards, has become increasingly complex. The bottom line is that financial executives within the retail industry cannot afford to be blindsided by tax, regulatory and financial reporting changes in this area,” cautioned Giles Sutton, Grant Thornton LLP State and Local Tax (SALT) partner and national Retail Tax practice leader.
The popularity of gift cards shows no sign of abating and will likely continue to grow as more consumers begin to use gift cards via convenient new mobile applications and to enjoy heightened consumer protections under the Card Act. The benefits to gift-card issuers remain numerous: increased sales, improved inventory management, better cash flow and higher profitability. While there is also more scrutiny of gift cards from the IRS and the FRB, the new rules mean more clarity for gift card issuers with respect to federal tax accounting rules and the financial accounting treatment of advance payments.
While many companies have done a significant amount of work in the past to ensure that they are able to recognize gift-card breakage income, companies must continue to evaluate and monitor the legislative changes in the various states in which they operate. The last thing retailers want is to have a financial restatement that is due to lack of awareness of changes in state laws affecting gift cards.
“With the increasing sales and use of gift cards, retailers will continue to focus on maximizing revenue and earnings from gift-card sales,” Sutton said. Maximizing earnings is dependent on minimizing breakage subject to state escheat laws, managing state income tax consequences of issuing and distributing gift cards, and achieving the ability to defer revenue from the sale of gift cards for federal income tax purposes. These will be ongoing issues for retailers for the foreseeable future.”
Giles Sutton, J.D., LL.M, State & Local Tax Technical Services partner and national Retail Tax practice leader, Grant Thornton LLP. He can be reached at email@example.com or (704) 632-6885.