In a 2—1 decision, the Third Circuit reversed the Tax Court and held that a corporation could deduct estimated costs of its customer reward program under the all-events test. The court remanded the case to the Tax Court after holding that the liability of the corporation's reward program was fixed because a unilateral contract was created at the time each customer earned reward points from a qualifying purchase.
Facts: In 2006 and 2007, Giant Eagle Corp., an accrual-basis taxpayer whose principal place of business was Pittsburgh, operated supermarkets, pharmacies, gas stations, and convenience stores. The company offered a customer reward program where customers earned one "fuelperks!" credit for every $50 they spent on qualifying purchases. When customers later purchased fuel, they could reduce its cost by 10 cents per gallon for each fuelperks! credit, up to 30 gallons. The fuelperks! credits expired three months after the last day of the month in which they were earned.
On its 2006 and 2007 income tax returns, Giant Eagle deducted the estimated amount of fuelperks! discounts earned by customers by the end of each tax year that would be redeemed in the following year. After the IRS disallowed the deduction for both years, Giant Eagle petitioned the Tax Court for relief.
The Tax Court held that the estimated discount amounts were not deductible under the all-events test of Regs. Sec. 1.461-1(a)(2)(i) because Giant Eagle's liability was not fixed until the fuelperks! credits were redeemed (Giant Eagle, T.C. Memo. 2014-146; see also "Tax Matters: Giant Eagle's Advance Deductions Grounded," JofA, Oct. 2014). In addition, the court held that the discount coupon exception to the all-events test (Regs. Sec. 1.451-4(a)(1)) did not apply to Giant Eagle because the fuelperks! credits were not redeemable for merchandise, cash, or other property, as their redemption was conditioned on a subsequent purchase. Giant Eagle appealed the decision to the Third Circuit.
Issues: Under Regs. Sec. 1.461-1(a)(2)(i), an accrual-basis taxpayer may deduct a liability for an expense when all events have occurred that establish the existence of the liability, the amount can be estimated with reasonable accuracy, and economic performance has occurred with respect to the liability. Regs. Sec. 1.451-4(a)(1) permits an accrual-basis taxpayer that issues discount coupons redeemable in cash, merchandise, or other property to reduce its current-year income by an amount equal to the estimated cost of redemptions. However, in Rev. Rul. 78-212, the IRS held that coupons that customers could use for discounted future purchases were not considered redeemable in cash, merchandise, or other property because the customer had to buy additional products to redeem them.
With respect to the fuelperks! discounts, the IRS conceded that the company had calculated its liability with reasonable accuracy and that economic performance had occurred but argued that the fact of the liability was not fixed at the end of the tax years in question.
Holding: The appellate court reversed the Tax Court and found that the fact of the liability for the fuelperks! discounts was fixed at the end of each tax year; thus, the estimated discount amounts were deductible. The court applied Pennsylvania contract law, holding that customers of Giant Eagle were parties to a unilateral contract when they shopped at Giant Eagle to earn reward discounts. Under a unilateral contract, a contract is created and becomes enforceable when the offeree completes performance. According to the court, the customers completed their performance when they purchased merchandise that earned fuelperks! credits, and those purchases fixed Giant Eagle's liability. The court stated that "it is irrelevant that neither the total amount of Giant Eagle's anticipated liability nor the identity of all the customers who eventually applied discounts toward gasoline purchases could be conclusively identified at year's end."
- Giant Eagle, Inc., 822 F.3d 666 (3d Cir. 2016)
—By Charles J. Reichert, CPA, instructor of accounting, University of Minnesota—Duluth.