Credit card reward liabilities may be eligible for recurring-item exception

The IRS Office of Chief Counsel advised in Chief Counsel Advice (CCA) 202417021 that certain credit card reward liabilities are fixed and determinable under Sec. 461 when the cardholder has the right to redeem the rewards for cash or a statement credit and that economic performance Under Sec.  461(h) occurs when reward payments are made to the cardholder in the form of cash, a statement credit, or other goods or services.  Furthermore, credit card issuers may deduct reward liabilities in the year they become fixed and determinable, utilizing the recurring-item exception under Regs.  Sec.  1.461-5, so long as the rewards are redeemed by the cardholder within 8½ months after the close of that tax year.

The CCA also highlights the position the IRS took in Action on Decision (AOD) 2016- 03, in which it declined to acquiesce to the Third Circuit’s decision in Giant Eagle, Inc., 822 F.3d 666 (3d Cir.  2016), rev’g T.C. Memo.  2014-146.  For further discussion of Giant Eagle, Inc., see “Tax Matters: Giant Eagle’s Advance Deductions Grounded” (JofA, October 2014) and “Tax Matters: Deduction Allowed for Unredeemed ‘Fuelperks!’” (JofA, October 2016).

Facts: Under the facts of the CCA, the taxpayer is a federally chartered bank that issues credit cards to cardholders.  These credit cards allow cardholders to earn rewards by accumulating miles, points, or cash spent and then redeem these points for cash, statement credits, travel, gift cards, and other goods or services.  Based on the transaction category, cardholders earn a different number of points per dollar charged.  To redeem these points, cardholders use the taxpayer’s website or mobile app to request redemption of reward points by specifying how many points the cardholder wants to redeem and then clicking the “redeem” button to initiate the redemption.  The taxpayer then immediately reduces the cardholder’s total points available and makes the redemption payment by sending a check, issuing a statement credit, or providing the cardholder with the selected reward benefit. In accounting for a specific tax year, the taxpayer deducts the liability it incurs for its credit card rewards when the rewards are redeemed.

The taxpayer would like to adopt, via an accounting method change, the recurring-item exception under Sec.  461(h)(3).  This would permit the taxpayer to deduct the liability for credit card rewards in the tax year in which the rewards are earned instead of the tax year in which they are redeemed.

Discussion: The CCA analyzed when credit card reward liabilities become fixed and determinable under Sec.  461, when economic performance occurs under Sec.  461(h) for credit card reward liabilities, and whether the taxpayer can adopt the recurring-item exception under Regs.  Sec.  1.461-5.

Under Sec.  461(a), any deduction or credit allowed should be taken in accordance with the method of accounting used in computing taxable income.  For an accrualbasis taxpayer, a liability (as defined in Regs.  Sec.  1.446-1(c)(1)(ii)(B)) is incurred, and generally taken into account for tax purposes, in the tax year in which all the events have occurred that establish the fact of the liability, the amount of the liability can be determined with reasonable accuracy, And economic performance has occurred with respect to the liability (Sec.  461(h); Regs. Sec.  1.461-1(a)(2)).

Following General Dynamics Corp., 481 U. S. 239 (1987), the CCA notes that all the events have not occurred to establish the fact of a liability if there is a “condition precedent that is not ministerial.” In contrast, the most recent consideration of this issue was in Giant Eagle, Inc., where the Third Circuit held that Giant Eagle’s anticipated liability for unredeemed gasoline discounts were fixed in the year earned for purposes of the all-events test.  The IRS, however, disagreed with this decision and subsequently issued the AOD.  In the AOD, the IRS explained that because the reward recipient was required to make an additional purchase of gasoline to redeem the gasoline discount, the liability was not fixed because the additional purchase was not a ministerial act and was, therefore, a condition precedent.

Ultimately, the CCA concluded that the credit card reward liabilities described in the current situation are fixed to establish the fact of the liability and the amounts determinable when they become redeemable for cash or a statement credit, because no additional purchase is required to redeem the rewards.  The CCA was careful to distinguish the facts that the memorandum was premised on from the holdings in Giant Eagle, Inc. and General Dynamics Corp. In particular, because the CCA’s scenario does not require an additional purchase, it is distinguishable from Giant Eagle, Inc., and because the redemption act itself is ministerial and not a condition precedent, it is distinguishable from General Dynamics Corp.

Turning to the question of economic performance under Sec.  461(h), when a taxpayer’s liability is to pay a rebate, refund, or similar payment to another person, economic performance occurs when payment is made to that other person.  The CCA reasoned that although rewards do not technically constitute a rebate, they are sufficiently similar to a rebate to constitute a “similar payment” under Regs.  Sec.  1.461- 4(g)(3).  As a result, the CCA concluded that economic performance for purposes of the all-events test is satisfied under Regs.  Sec. 1. 461-4(g)(3) when the redemption payment is made.

Finally, given the facts at issue, the CCA contemplated whether the taxpayer would be eligible for the recurring-item exception under Sec.  461(h)(3) and Regs.  Sec.  1.461- 5. It concluded that the taxpayer would be eligible because the liability is fixed and determinable, recurring in nature, and “the accrual of the liability for that taxable year results in a better matching of the liability with the income to which it relates.” As a result, the taxpayer may satisfy the all-events test where economic performance occurs “on or before either the earlier of the date Taxpayer files a timely return (including extensions) or the 15th day of the 9th month after the close of that taxable year.”

Conclusion: The CCA articulated three main conclusions: (1) credit card reward liabilities become fixed and determinable under Sec.  461 when the cardholder has the right to redeem the rewards for cash or a statement credit; (2) economic performance Occurs under Sec.  461(h) and Regs.  Sec. 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; and (3) credit card issuers may adopt the recurring-item exception under Regs.  Sec.  1.461-5 to deduct reward liabilities in the year that they become fixed and determinable, provided that the rewards are redeemed by the cardholder within 8. Months after the close of that tax year.

∎ CCA 202417021

— Matthew Geiszler, Ph.D., is a lecturer in accounting in the Brooks School of Public Policy; John McKinley, CPA, CGMA, J.D., LL. M., is a professor of the practice in accounting and taxation in the SC Johnson College of Business; and Keshaav Pothapur is a student in the Sloan MHA program in the Brooks School of Public Policy, all at Cornell University. To comment on this column, contact Paul Bonner, the JofA’s tax editor.