Deduction of Accrued Customer Loyalty Program Points

| 5/19/2016

The U.S. Court of Appeals for the 3rd Circuit overturned a 2014 Tax Court memorandum decision and handed taxpayers a significant victory in Giant Eagle Inc., v. Commissioner of Internal Revenue. The Court allowed the taxpayer, an owner and operator of supermarkets and gas stations, a current deduction for accrued customer loyalty points earned but not paid during a tax year.

The taxpayer awarded loyalty points to customers in exchange for the purchase of merchandise at its supermarkets. The loyalty points could be used to reduce the price of fuel purchased at one of the taxpayer’s gas stations. The fuel points were not redeemable for cash or other property and expired three months from the date earned. The taxpayer claimed a deduction for its unredeemed fuel points using a formula that estimated the portion of the fuel points outstanding at year-end that ultimately would be redeemed based on historical redemption rates.

The deductibility of an accrued expense is based on the all-events test, which is met only when all of the following events have occurred:

  • The fact of a liability exists.
  • The amount of the liability can be determined with reasonable accuracy.
  • Economic performance has occurred with respect to the liability.

Contrary to the Tax Court’s original ruling, the Court of Appeals held the following:

  • Issuance, not use, of the fuel points established the fact of the liability.
  • The taxpayer’s method of estimating accrued fuel points determined the amount of the liability with reasonable accuracy.
  • The taxpayer met economic performance by use of the recurring item exception.

Economic performance for accrued rebates, refunds, and similar items generally is established by payment of the rebate. However, when the other parts of the all-events test have occurred, the recurring item exception works to deem economic performance as occurring if payment of the rebate occurs before the timely filing of a tax return for the current year, the rebate is recurring in nature, and the rebate is either not material or is better matched against income in the current year.

The ruling in this case is particularly valuable as when establishing the fact of the liability it treats as irrelevant the fact that customers may not use the fuel points prior to their expiration. The short expiration time period may work in the taxpayer’s favor in that a substantial amount of the liability either will be paid out or will expire before the tax return is filed for that year. Because the deduction was premised on the use of the recurring item exception, taxpayers that have loyalty programs that allow unredeemed points to be used over a long period of time may have fewer points redeemed that meet the recurring item exception.

The ruling has precedential authority only within the 3rd Circuit (Delaware, New Jersey, and Pennsylvania). Taxpayers with established methods of accounting for similar loyalty programs that are not consistent with the 3rd Circuit’s holding should evaluate whether filing a Form 3115, “Application for Change in Accounting Method,” to adopt the method used by Giant Eagle is worthwhile. Because the ruling currently is limited to the 3rd Circuit, the IRS National Office may deny any change in method of accounting request outside the 3rd Circuit.

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