IRS Guidance Accelerates Deduction for Credit Card Reward Programs
May 21, 2024
On April 24, 2024, the Internal Revenue Services (IRS) issued Chief Counsel Advice 2417021 (CCA), which discusses the treatment of credit card reward liabilities under Internal Revenue Code (IRC) section 461. The CCA was issued in direct response to the following questions presented by the U.S. Department of the Treasury regarding rewards liability accounting:
- When do credit card reward liabilities become fixed and determinable under section 461?
- When does economic performance occur for credit card reward liabilities under section 461(h)?
- May a taxpayer adopt the recurring item exception under Treasury Regulation (Treas. Reg.) section 1.461-5 for credit card reward liabilities?
The concludes that credit card reward liabilities become fixed and determinable when cardholders have the right to redeem the rewards. While the CCA conclusions provide important guidance to credit card issuers, such as banks, that operate reward programs, it may not be used or cited as precedent.
Background Facts and Circumstances
The taxpayer in question in the CCA is assumed to be a federally chartered bank that issues credit cards offering rewards in the form of points, miles or cash that may be used for statement credits, travel, gift cards, cash or redeemed for other goods or services. The cardholder can exercise the option to redeem the rewards at any time after the rewards are received. Additionally, the taxpayer does not have redemption thresholds, and rewards are redeemable immediately upon receipt at the close of the cardholder’s billing period. The cardholder has no obligation to make additional purchases before redeeming the reward.
Currently, taxpayers deduct their accrued liability for credit card rewards in the tax year in which the cardholder claims the reward payment. The CCA provides a path for taxpayers to adopt the recurring item exception for credit card rewards accrued liabilities. Consequently, a taxpayer may accelerate the credit card rewards deduction to the tax year in which the rewards are granted to the cardholder. This acceleration of the deduction can apply when the cardholder claims the reward payment either during the tax year, or up to eight and a half months after the tax year ends.
Questions and Conclusions of the IRS
- When do credit card reward liabilities become fixed and determinable under section 461?
- Credit card rewards liabilities become fixed and determinable under section 461 when the cardholder has the right to redeem the rewards for cash or a statement credit without the requirement of an additional purchase under the reward program.
- When does economic performance occur for credit card reward liabilities under section 461(h)?
- Economic performance occurs under section 461(h) and Treas. Reg. section 1.461-4(g)(3) when reward payments are made to the cardholder in the form of cash, a statement credit or other goods or services.
- Can a taxpayer adopt the recurring item exception under Treas. Reg. section 1.461-5 about credit card reward liabilities?
- Card issuers may adopt the recurring item exception under Treas. Reg. section 1.461-5 to deduct reward liabilities in the year that they become fixed and determinable, provided the rewards are redeemed by, or paid to, the cardholder within eight and a half months after the close of that taxable year.
Law and Analysis
The IRS in the CCA notes that credit card issuers may not deduct anticipated expenses, only expenses driven by actions taken by cardholders to redeem their rewards. A taxpayer may not deduct an estimate of an anticipated expense, no matter how statistically certain, if it is based on events that have not occurred by the close of the taxable year or within eight and a half months following the tax year for the recurring item exception. This standard was originally put in place after United States v. General Dynamics Corp.
The CCA indicates that if a rewards program requires a subsequent purchase, the liability would not be considered fixed under the all-events test. The Giant Eagle, Inc. v. Commissioner of Internal Revenue case reversed Tax Court Memo 2014-146, denied taxpayers’ fuel rewards program deductions. In the Giant Eagle case there was a condition precedent, a non-ministerial act of purchasing fuel for a customer to redeem the rewards, and therefore the liability was not fixed under the all-events test. Only when the customer purchased fuel was the liability fixed.
The IRS distinguished the credit card rewards program facts in the CCA from the two cases cited above to reach its conclusions for deductibility of the accrued expense. The liability accrued in the CCA is fixed and determinable after each monthly billing period because the cardholder can immediately redeem their rewards for a predetermined amount of cash or a statement credit and there is no condition precedent or need for a subsequent purchase.
Economic performance subsequently takes place when the cardholder redeems their rewards, and the credit card issuer pays out the reward to the cardholder. This is consistent with how rebates are recognized under Treas. Reg. section 1.461-4(g)(3). Therefore, card issuers may use the recurring item exception method of accounting to deduct credit card rewards in the year the liability is fixed and determinable and subsequently redeemed and paid to the cardholder within eight and a half months after the close of the taxable year, resulting in a better matching of income and expense.
Final Thoughts
While the CCA may not be relied upon as precedence, credit card issuers should evaluate their reward programs to determine if there is an opportunity to adopt the recurring item exception method of accounting and accelerate deductions to an earlier tax year.
Your Guide Forward
Please contact your Cherry Bekaert tax advisor with any questions and to discuss how to adopt this accounting method change or how to adopt the recurring item exception for this liability.