Gift Card Accounting and Tax Compliance for Restaurants

Many restaurant operators issue and use gift cards in a variety of ways. There is the straight forward sale of gift cards to customers that they use as gifts to friends, family, and colleagues, and restaurants also use gift cards in promotional events.

Beyond their obvious benefits, gift cards introduce unique accounting considerations that every restaurateur needs to understand.

Key Takeaways

• Gift cards are a liability, then revenue: Initially a liability, gift card value can be recognized as income (breakage) when redemption is unlikely, adhering to ASC 606.
• Tax deferral options: The IRS allows deferring gift card income recognition for tax purposes to the subsequent year, offering flexibility.
• State laws matter: Be aware of varying state laws regarding gift card expiration and unclaimed property.
• Consistent strategy is important: Implement a consistent methodology for gift card accounting and consult with your tax preparer.

Accounting Treatment of Gift Cards

The normal treatment of these cards from an accounting standpoint is that the card value sits on the balance sheet as a long-term liability until the card is redeemed, at which time the liability is reduced and the sale associated with the card is recognized on the financial statement as income.

In the past, this liability continued until the value was redeemed or expired. Operators need to be aware of the local and state rules regarding gift card expiration.

For example, in California, gift cards cannot have an expiration date. Current data shows that the redemption rate for gift cards is roughly 56% within the first six months.

Shifting Gift Card Liability to Revenue

Running a large, long-term liability on the balance sheet is impractical, knowing that after the first six months the rate of redemption falls from the 56% average dramatically. Many operators have established a practice to “derecognize” this liability based on a “breakage” calculation.

The operator then can recognize the income from the gift cards where it is unlikely that goods or services will ever be exchanged, either (a) the likelihood of redemption of the gift cards or portions thereof is considered remote; or (b) over the period in which the remainder of the gift card is expected to be used.

ASC 606 and IRS Section 451: Accounting Standards for Gift Cards

ASC 606, a revenue recognition standard, provides specific guidance for restaurant operators on how the “derecognize” gift card liability. Proceeds from gift card sales are considered as advance payments which has to be recognized as income in the year of sales for federal income tax purposes.

In 2017, the IRS amended Section 451 of the Internal Revenue Code. The amendment allows restaurants to defer the recognition of income for federal income tax purposes for the sale of gift cards from the year of sale into the subsequent tax year.

Full-Inclusion vs. One-Year Deferral for Tax Purposes

Two Methodologies for Compliance

Restaurant operators need to adopt one of two methodologies in order to comply with revenue recognition rules:

• Recognize the income from gift cards upon the sale within the current tax year (full-inclusion method), or
• Deferral until the subsequent year (one-year deferral method).

Alignment with Financial Statements

Be aware that the timing of income recognition for federal income tax purposes cannot be later than the timing for applicable financial statement purposes. This means that restaurant operators can continue to recognize income at redemption (which could be longer than a year) for financial reporting purposes while adopting one of the two methods above for income tax purposes.

Gift Cards and Unclaimed Property Laws

Gift cards are generally subjected to abandoned and unclaimed property rules but it is an unpaid contractual liability. Unclaimed property laws vary from state to state. Some states exempt gift cards from unclaimed property rules, for example California.

Gift Card Management: Best Practices for Restaurateurs

Taking these changes into consideration, restaurateurs need to evaluate their use of gift cards primarily for promotional purposes. They also need to establish data that helps determine a reasonable time frame to recognize the income from gift cards and reduce their long-term liability on their balance sheet.

Operators should address this issue with their tax preparer and execute a methodology that is consistent from year to year.

If we can be of assistance in helping you evaluate and establish consistent practice, please reach out.