Retailers commonly offer discounts, either through coupons or “customer loyalty” programs, in order to attract repeat business. If your Florida small business chooses to offer such discounts, it is important to be aware of the potential tax and accounting implications. One Pennsylvania retailer recently learned it must pay more than $3.7 million in back taxes as a result of failing to properly account for their customer loyalty program.
Giant Eagle, Inc. v. Commissioner of Internal Revenue
Giant Eagle is a successful supermarket chain based in Pittsburgh. Giant Eagle also operates a gas-and-convenience store chain under the name GetGo. In 2006 and 2007, Giant Eagle ran a customer loyalty program called “fuelperks!” Under this program, for every $50 a customer spent at Giant Eagle, he or she would receive a 10-cent discount on a future gas purchase at GetGo. Customers could accumulate multiple discounts through the use of loyalty card, so in theory he or she might acquire enough 10-cent discounts to get a free gas purchase. Customers had to redeem the discounts in the same month they were earned, and they could not redeem the discounts for cash.
Giant Eagle’s accounting of the fuelperks program eventually led to a dispute with the Internal Revenue Service. Like many inventory-based retailers, Giant Eagle uses an accrual method of accounting. This means income and expenses must be recorded at the time they are earned or incurred, respectively. Under federal tax law, a business using the accrual method must record a liability in the year “all the events” necessary to establish the liability take place. This would apply to business expenses such as the cost of administering Giant Eagle’s fuelperks program.
In its 2006 and 2007 federal tax returns, Giant Eagle claimed more than $7 million in unredeemed and unexpired “fuelperks” discounts as a business expense. The IRS disallowed this deduction. Giant Eagle challenged the IRS decision, but on July 23 of this year, the U.S. Tax Court, an administrative tribunal that hears tax-related appeals, ruled for the government.
The IRS argued, and the Tax Court agreed, that the “fuelperks” claimed expense did not meet the requirements of the “all events” test. Simply put, Giant Eagle could not offset the estimated future cost of redeeming discounts that customers had yet to take advantage of. The “all events” rule means Giant Eagle cannot incur an expense until the final event—the customer redeeming the discount for a gasoline purchase—takes place.
The Tax Court’s decision means Giant Eagle is on the hook for an additional $3.7 million in back taxes. It’s a costly lesson that should cause other retailers to take notice. Retailers must always be aware of the potential implications of their discount programs and other business practices. If you need advice on this or any other subject, contact Florida business attorney John S. Sarrett today