As the holiday season approaches, gifts will be bought with increasing frequency. Have you ever considered how gift cards that go unredeemed are viewed by Federal and State taxing authorities? What are the revenue recognition rules and the escheatment standards that companies need to be aware of?
The timing of recording taxable income related to the sale of gift cards depends on a few different factors. The first question to ask yourself is whether your company reports their income taxes on the cash basis or the accrual basis. If on a cash basis, the answer is simple. Taxable income is recognized when the gift card is sold. The timing of the actual use of the gift card is irrelevant.
For companies using the accrual basis of accounting, there are two choices: full recognition or deferred recognition. Full recognition is simple; this simply puts the sale of gift cards on a cash basis, so income is recognized when the gift card is sold. While this method does not allow for any deferral of income, it’s simplicity may be favored by companies without robust tracking systems of gift card sales and related redemptions, or companies who just do not sell very many gift cards. The alternate method, deferred recognition, allows companies to defer the recognition of gift card sales for income tax purposes, but only for a certain period, and only for those that have not yet been redeemed. Any redeemed gift card must be recognized in the year redeemed, which is why thorough tracking is so important. For gift cards that go unredeemed, the related revenue may be deferred for one tax year. If sold during the calendar year 2018 and unredeemed at the end of 2018, the revenue from that gift card can be deferred until the 2019 tax return.
An additional complication exists for companies whose gift cards are likely to be redeemed for goods that can be inventoried. These companies can defer their unredeemed gift card revenue for two years from date of sale, rather than the standard one year. Restaurants are unlikely to qualify for this two-year deferral, however.
Do gift cards ever expire? Do unused cards escheat to the state at some point? These decisions are left up to each state, so it varies greatly on where the card was purchased. It also depends on the form of the gift card, whether it be a physical gift card or electronic or a certificate instead. Below are a few notable states and their applicable rules.
- Gift cards (digital and non-digital) and gift certificates shall never escheat to the state and are exempt from reporting requirements.
- Generally, gift cards and gift certificates are exempt from reporting and escheat requirements. However, those that have an expiration date are presumed abandoned if left unclaimed by the owners for more than three years after they become payable or distributable.
- After becoming payable or distributable, gift cards are subject to escheat provisions after five years of non-use. Gift certificates issued only on paper are not subject to these provisions.
Gift Cards to Employees
The IRS labels gift cards as a fringe benefit. Fringe benefits can be taxable or nontaxable, depending on the type of fringe benefit and amount. Are gift cards from employers taxable income and subject to payroll tax? While many infrequent gifts to employees are deemed de minimus and nontaxable, gift cards are considered supplemental income and should be included an employee’s income and thus, is taxable income. As such, the amount of the card is subject to Social Security and Medicare taxes as well. The rationale behind this makes sense: gift cards are a cash equivalent, and cash paid in addition to employee’s regular wages is considered supplemental wages, which are fully taxable.
After withholding mandatory taxes and accounting for income taxes, employees may be disappointed to find out they are only receiving a fraction of the gift card’s value. To account for this, employers can gross up the amount of the gift card using a percentage method. For example, if wanting to give an employee a $100 value, employers should include federal taxes, applicable state and local taxes, Social Security, and Medicare taxes in the amount of the gift card. For example, if the typical combined federal, state, and local income tax rate is 30%, add that to the Medicare and Social Security rate of 7.65%, and the gift card should be $160.38 (recording it as $160.38 of supplemental income, and withholding $60.38).
For more on any of these topics or advice on handle gift cards as an employer, please consult with a Henry+Horne tax advisor that has experience handling these tax issues to make sure your business stays compliant.
Austin M. Bradley, CPA