Understanding Gift Cards for Your Restaurant

Retailers, restaurants, and even e-commerce businesses provide gift cards as a way to expand their customer base and build brand loyalty. Those gift cards are used to redeem meals, merchandise, and services across a wide range of industries. Gift cards continue to be a significant source of revenue for many businesses.

In fact, nearly 60% of consumers in recent marketing polls said they were interested in receiving gift cards as items on their wish list. This includes everything from books, electronics, home décor, personal care, and home improvement, to name a few. This will continue to drive the growth in selling gift cards.

While gift cards are prevalent in many businesses, there continues to be misconceptions on the impact to a business’ financial statements and tax returns when considering how to report income related to the cash received when issuing a gift card, as well as with the redemption of that gift card.

When accounting for gift cards on a financial statement, the basic tenant is that the cash received is not an asset of the issuer of the gift card, but rather, it really is a liability to provide services or a product at some future time. The Company ultimately creates a liability for the cash it receives for the issuance of the gift cards.

It is when the service is performed or the product is provided upon redemption of the gift card, that the Company will recognize the income as it would under any other transaction. Any gift cards that remain unredeemed, the Company will continue to hold the liability on its books.

The tax treatment of the gift cards is where the misconception and confusion on when the income recognition arises. Many restaurant operators, retailers, and other businesses selling gift cards tend to follow the financial statement treatment and recognize income only when the gift cards are redeemed. This is where businesses may find themselves out of compliance with the tax law.

Note, a cash-basis taxpayer will report income when cash is received at the time of issuance of the gift card.

For accrual-basis taxpayers, taxpayers must recognize taxable income on the redemption of the gift card if the gift card is redeemed in the year the gift card was purchased, or, if not redeemed in the same year the business received cash, the income can be deferred for one year after cash receipt, regardless of whether the gift card is redeemed. As you can see, if a gift card is left unredeemed beyond the year after the cash was received, the business may be reporting income on the cash received before the services are rendered or product is delivered.

While there is this ability to defer income up to one-year where applicable, the taxpayer could decide to report income in the year of cash receipt instead of deferring. This would happen if there were tax saving advantages to the taxpayer (for example: the taxpayer was in losses and reporting the income immediately did not put the business into income). For taxpayers that cannot track their gift cards, they must recognize the revenue in the year of the gift card sale. The latter is what we see more often with many of our businesses.

Consider the following example:

Gift Card A was purchased in 2022 for $50. It was unredeemed as of the end of 2023. This means that for tax purposes, the $50 of cash, if the business tracks its gift cards, must be reported in income no later than its 2023 return. The financial statements will not include income for this until the gift card is redeemed.

As alluded to above, there is further complexity related to whether businesses’ track their gift cards. Many POS systems require additional fees in order to unlock features to track gift card usage. If gift cards are not tracked, then there is no way to know when the gift card was redeemed relative to when the cash was received to issue the gift card. As stated above, in an instance that a business cannot or does not track its gift cards, it may be required to recognize income in the year of cash receipt, rather than being able to defer the income into a future year.

This will likely catch many restaurants, retailers, and other businesses unaware of a revenue recognition event. While some will say this is merely a timing issue in that some day there will be income reported on the cash received, the IRS does not see it that way. Their view is that there could be income that should have been reported on prior returns when the gift cards are left unredeemed for a longer period of time. This could cause havoc, especially if the business is a partnership, LLC taxed as a partnership, or an S Corporation. Should the IRS look at this and require changes to taxable income in prior years, this would result in amended returns for both the business and its shareholders. This is both a costly and inconvenient result for businesses and their owners.

Further adding to the complexity of gift cards are various State regulations regarding the expiration dates of gift cards and escheating of gift cards. California is a state that does not have expiration on gift cards. This could lead to unclaimed property tax issues. Most states have laws that require reporting unclaimed property on unredeemed gift cards if left unredeemed for a period of time. Some states go further and require that a business releases those unredeemed gift cards to a respective State in certain instances.

A takeaway is that your business should understand how it accounts for gift cards, how it treats the income for both financial statement and tax purposes and understanding whether your business can get access to a reliable gift card tracking system. Understanding federal and state law implications is critical as well. If your business is reporting income on its tax returns when the gift cards are redeemed, you are opening the business up to potential adjustments to the timing of income, which may lead to tax payments you were not expecting or fees in amending returns for the business and its shareholders.