IRS says credit card reward liabilities can be deductible

The IRS has concluded in a recently issued Chief Counsel advice memorandum (CCA 202417021) that certain credit card reward liabilities are deductible when the cardholder has the right to redeem the rewards. The guidance could provide an opportunity for taxpayers to accelerate deductions for credit card reward liabilities generated though similar qualifying reward programs. 

Section 461 and the regulations thereunder generally provide that a liability is deductible under the accrual method of accounting in the taxable year in which all events have occurred that establish the fact of the liability and the amount of the liability can be determined with reasonable accuracy (the all-events test) and economic performance has occurred with respect to the liability. Taxpayers may adopt the recurring item exception to deduct a liability in the taxable year in which the all-events test is met, even if economic performance occurs in the subsequent taxable year. In general, to apply the recurring item exception, the liability must be recurring in nature and either not material or the accrual of the liability in the taxable year in which the all-events test is satisfied must result in a better matching of the liability with the associated income.

The CCA addressed a bank that issues credit cards to cardholders. Under the bank’s reward program, cardholders are eligible to earn certain credit card rewards, which are redeemable for a variety of benefits, including cash, statement credits and third-party gift cards. Rewards are redeemable immediately upon receipt, with no additional purchase requirements. At the time of redemption, the taxpayer makes a redemption payment by sending a check, issuing a statement credit, or otherwise providing the cardholder with the selected reward benefit.

A fundamental component of establishing if the all-events test has been met is identifying the point at which the liability is fixed. The CCA briefly addressed case law that analyzes when a liability becomes fixed, including United States v. General Dynamics Corp., 481 U.S. 239, 243–44 (1987) and Giant Eagle, Inc. v. Commissioner, 822 F.3d 666 (3rd Cir. 2016).

In General Dynamics, the U.S. Supreme Court ruled in favor of the IRS, holding that the taxpayer could not deduct incurred but not reported expenditures associated with its self-insured medical plan because the last event necessary to fix the liability was the filing of properly documented claims forms, a non-ministerial condition precedent. In the CCA, the IRS distinguished the taxpayer’s facts from General Dynamics, indicating that, because the credit card rewards are immediately redeemable for a predetermined amount of cash or a statement credit and there is no additional purchase required to redeem the rewards, the right to redemption for cash or a statement credit is fixed. The redemption act is ministerial.

In Giant Eagle, a super­market chain issued loyalty gasoline discounts to its ­customers when they made a certain amount of grocery purchases. The customers could use the discounts, which expired three months after ­issuance, only when they purchased gasoline at certain locations. The Tax Court decided that the discount liability was not fixed at year-end since redemption was contingent upon the customers’ future gasoline purchases. Thus, it could not be deducted currently.

The Third Circuit, however, overturned the Tax Court’s decision and held that the taxpayer met the all-events test and could deduct an estimate of the amount of unredeemed discounts that would be redeemed in the subsequent year. The IRS disagreed with the Third Circuit’s decision and issued an Action on Decision (AOD) that reiterated the agency’s position that a “taxpayer’s liability for its unredeemed discount coupons is not fixed before the customer purchases the fuel” because the additional purchase of gasoline is not a ministerial act. The CCA agreed with the IRS’s AOD, but distinguished the taxpayer’s facts from those in Giant Eagle as the cardholders are not required to make additional purchases to receive the reward benefit. Thus, redemption is ministerial under the taxpayer’s program. 

In the CCA, the IRS concluded that the credit card rewards are a rebate, refund or similar payment and, therefore, a payment liability for which economic performance occurs when the redemption payment is made. Further, the IRS stated that the credit card rewards are eligible for the recurring item exception because the liability is fixed and determinable at the end of the taxable year in which the credit card rewards are earned, they are recurring in nature, and accruing the liability for that taxable year results in a better matching of the liability and the income to which it relates. Such better matching is specifically provided for in the Treasury regulations.