Gift card sales represent a huge revenue opportunity, but also a potential franchise accounting headache.
When a card is purchased, the franchise must account for the purchase as a liability. Once the card is redeemed for products or services, it can be recognized as revenue. That seems straight forward enough.
However, addressing the timing of your IRS obligation is a bit more complex. Depending on if your business uses a cash basis or accrual basis accounting method, taxes must either be redeemed in full or may be deferred. If your accounting system follows a cash basis, card revenue must be recognized in its entirety when the sale is made (for tax purposes). If you follow an accrual method, you have the choice of either immediate, full revenue recognition or deferring the card revenue for up to two years. Either way, you may be paying taxes on gift cards that have not yet (or perhaps never will be) fully redeemed.
What if gift cards are never redeemed?
Your chosen accounting method is just one IRS compliance consideration. Abandoned property rules, particularly for franchisees that operate in multiple states, also demand thoughtful attention. Why? Every state has a different way of handling so-called breakage, which in this case means gift cards that are never fully redeemed for goods and services.
Abandoned property or “escheat” laws for gift card-issuing businesses incorporated in Colorado changed in 2020; it eliminated a $25 de minimus reporting deduction. Under the old rules, a company could retain $25 or 2% of the unredeemed card value before returning the remainder to the state as abandoned property. However, today the state treasurer must receive the entire value of abandoned property. Colorado exempts “gift cards” when the holder’s or issuer’s gross receipts from the sale or issuance of gift cards is $200,000 or less. This is only Colorado law. Every state’s rules can be different.
Cash flow considerations
Gift card revenue also requires careful management for cash flow and budgeting purposes. You may encounter a large percentage of gift card sales in the fourth quarter when your customers purchase holiday gifts. Until these sales are recognized as true revenue, as described above, you don’t want to spend it or budget for it as though it is revenue.
Whether you are considering implementing a gift card program or evaluating your current gift card accounting, there are a few important accounting concerns worth examining, including:
- Are you aware of current local, state and national regulations regarding gift card sales?
- Do you (and your accounting system) need to accurately track multistate gift card sales and revenue recognition?
- Are you going to follow cash or accrual rules for tax treatment of card revenue recognition?
- Is your business subject to abandoned property or escheat laws regarding gift card sales?
Gift cards can be an enormously worthwhile revenue generator, but they do require careful financial management. If you have high redemption periods for gift cards, such as after the holiday season, it can affect your cash flow. Unredeemed gift cards also represent a liability on your financial statements, which can impact financing or the opportunity to buy or sell a business.
Franchisees—particularly businesses that operate multiple locations, in multiple states, and perhaps multiple brands—would do well to consider the assistance of a CPA with experience in both franchise accounting and gift card accounting to advise on their card program.