and Anthony J. Balden
There have been several recent tax accounting developments. The most
significant is important new legislation that allows businesses to
deduct 100 percent of the cost of qualifying property. Because the new
provision has a limited time horizon, it is important to evaluate
whether the new provision is applicable to recent capital acquisitions
to take full advantage of this generous new provision.
Additionally, for certain companies with significant gift card
revenue, recently-released administrative guidance may allow deferral
opportunities. Thus, both the new legislation and the new procedures may
favorably impact cash flow, accelerating certain depreciation
deductions and deferring certain gift card income. Although these
disparate items have limited application, these items may provide a
significant benefit for certain companies.
A third item provides additional procedural guidance regarding the
implementation of certain accounting method changes. Companies should
consider these new rules to identify investment opportunities and
achieve clarity in their treatment of various items. The following is a
discussion of these new rules and an overview of potential implications.
Since 2002, Congress has enacted several provisions that permit
accelerated cost recovery through depreciation ("bonus depreciation") of
capital asset purchases in an effort to encourage business investment.
Prior to the recently-enacted legislation, certain "qualified property"
was allowed 50 percent bonus depreciation in the year the property was
placed in service rather than having property costs depreciated over a
longer period as provided in the general provisions in Sections 167 and
As part of what the White House described as the "largest temporary
investment incentive in history," President Obama signed the Tax Relief,
Unemployment Insurance Reauthorization and Job Creation Act of 20101
into law in December. Specifically, the legislation is designed to
encourage additional investment in certain business property by
providing 100 percent bonus depreciation. Combined with the extension of
numerous other tax cuts and other provisions, the purpose of this
legislation is to avoid having capital "waiting on the sidelines," and
the administration hopes it will spur growth in the economy. The new
bonus depreciation deductions do not increase total deductions; the
timing of when deductions are taken into account is simply accelerated.
It is important to note that not all property qualifies for bonus
depreciation. In general, "qualified property" is limited to (i)
tangible property with a recovery period of 20 years or less, (ii) the
original use of which began after December 31, 2007, (iii) which was
acquired by the taxpayer in 2008, 2009, or 2010, and (iv) was placed in
service before January 1, 2011.2
Special rules exist for certain types of property, such as computer
software, water utility property, leasehold improvements, transportation
property, and certain aircraft, and extensions of deadlines apply in
some instances. Under the new bonus depreciation rules in Section
168(k)(5), a business placing qualified property in service after
September 8, 2010, and before January 1, 2012 (again, with extended
deadlines for certain property), may claim 100 percent bonus
depreciation on the property.
During a recent American Bar Association meeting, Treasury and IRS
officials, speaking on their own behalf, discussed some of the issues
that are expected to be addressed by the upcoming guidance. Of
particular importance, the officials noted that additional guidance on
bonus depreciation is expected shortly, perhaps as soon as the end of
One interesting issue has arisen regarding whether companies may
claim 50 percent bonus depreciation instead of claiming 100 percent
bonus depreciation. If companies already have losses or little current
income, then bonus depreciation deductions in the current year are less
valuable. Section 168(k)(2)(D)(iii) currently only permits an election
out of bonus depreciation on a class-by-class basis, thus, the statute
may be interpreted as disallowing the smaller bonus depreciation.
Also, some taxpayers have questioned the treatment of property
acquired pursuant to binding contracts that meet the definition of
qualified property but do not meet the post-September 8, 2010,
requirement. The new binding contract rule is liberal, but application
of the acquisition date requirement may restrict the availability of 100
percent bonus depreciation. The interaction of these provisions is
subject to some debate. Assuming the property meets the other
requirements of Section 168(k), a business acquiring property under a
binding contract signed on September 1, 2010, could potentially claim 50
percent bonus depreciation, but there is some question whether it could
claim 100 percent bonus depreciation. Future guidance is expected to
definitively resolve this question.
Finally, some questions remain regarding self-constructed property
and whether such property is subject to the acquisition date
requirements in Section 168(k)(5). Self-constructed assets are generally
deemed to be acquired once construction begins.3
To be eligible for 100 percent bonus depreciation, the property must
have been acquired after Sept. 8, 2010. There is a safe harbor for
purposes of the bonus depreciation provisions under which construction
is not deemed to begin and, therefore, property is not considered
acquired, until more than 10 percent of the costs of such property are
Bonus depreciation provides significant cost recovery acceleration
for businesses, and taxpayers should be aware of this new provision and
its limitations. We will continue to follow developments in this area
and assist taxpayers in using these rules.
Gift Card Guidance
Gift card sales are a significant percentage of sales for many
retailers, and they present a number of unique issues. Gift card issuers
and gift card programs have encountered increased scrutiny by the IRS
and at the state level in the last several years. The IRS has reviewed
issuers and arrangements generally with a focus on income recognition
timing, while states have looked to escheat laws to require surrender of
unused gift card balances. Commentators have noted that issuers and
arrangements, in turn, have become more complex, forming new
arrangements and structuring to avoid escheat laws. Rev. Proc. 2011-1756
provide guidance on two key gift card issues: the treatment of gift
cards issued for returned merchandise and gift cards issued by a third
party. and Rev. Proc. 2011-18
Often, returned merchandise entitles a customer to store credit or a
gift card instead of a cash refund. In Rev. Proc. 2011-17, the IRS
provides a safe harbor accounting method for the treatment of gift cards
issued in exchange for merchandise returns. Under this safe harbor, a
gift card issued for returned goods may be treated as payment of a cash
refund in the amount of the gift card followed by a purchase of a gift
card, allowing use of the income deferral provisions of Treas. Reg. §
1.451-5 and Rev. Proc. 2004-34. As such, a company may simultaneously
reduce its income by the amount of the gift card and also defer income
recognition through the deemed sale of the new gift card.
By way of background, Section 451 requires income recognition when a
payment is received, unless the income is properly recognized in another
period under the taxpayer's accounting method. For accrual taxpayers,
the year of income inclusion is determined under the all events test,
which requires income recognition when all events have occurred that fix
the right to receive the income and the amount can be determined with
Important exceptions allow the deferral of "advance payments" for one
or two years based on the taxpayer's recognition of payments under its
accounting method for financial reporting purposes.8
Treas. Reg. § 1.451-5(a)(1) defines an advance payment as "any amount
which is received in a taxable year by a taxpayer using an accrual
accounting method for purchases and sales." Advance payments must be
included in income when received or, as mentioned above, when included
in gross receipts for purposes of financial statements or other reports,
allowing for deferral of the income.9
Rev. Proc. 2004-34 provides additional rules allowing income deferral
for advance payments. It sets forth a more detailed definition of
advance payments, including payments for services, sales of goods, the
use of intellectual property, and other items, and excluding items like
rent, insurance premiums, and payments with respect to financial
instruments. It also lists permissible methods of accounting for these
advance payments, including immediate inclusion of the full amount and
deferral based on Treas. Reg. § 1.451-1.
Rev. Proc. 2011-17 notes an interesting dichotomy of treatment for
merchandise returns. If merchandise is returned in exchange for a gift
card, the seller does not have a "fixed liability" for purposes of
Section 461, which also applies the all events test and a performance
test for liabilities.10
Conversely, if merchandise is returned for cash, the seller may
immediately deduct the payment from its gross receipts. If the customer
then uses the cash to purchase a gift card, the seller, if its
accounting method allows, may defer the item from gross income under
Treas. Reg. § 1.451-5 or Rev. Proc. 2004-34.
To minimize disputes and to provide for a better matching of income
and costs, Rev. Proc. 2011-17 allows a taxpayer to treat gift cards
issued for returned goods as a payment of cash followed by the sale of a
gift card. Taxpayers wishing to make this change may do so under the
automatic consent procedures or under the advance consent procedures if a
change to a proper accounting method is also required. Rev. Proc.
2011-17 is effective for taxable years ending on or after December 31,
Rev. Proc. 2011-18 recognizes a more recent issue facing gift card
issuers and modern business structures. Gift cards are often redeemed by
a retailer that is not the issuer of the gift card. As discussed above,
state escheat laws and other structuring concerns have led to gift card
subsidiaries being formed that may or may not redeem the cards directly
with customers. Rev. Proc. 2011-18 notes other situations in which a
cooperative or membership organization offers cards redeemable by any
member entity and other arrangements allowing gift cards to be redeemed
by related or unrelated parties. Significantly, Rev. Proc. 2011-18
allows these entities to take advantage of special deferral provisions
despite the fact another taxpayer actually redeems the gift card.
Typical gift card arrangements allow the card issuer to hold the
proceeds until the card is used. The seller of goods or services,
pursuant to its arrangement with the gift card issuer, is obligated to
accept the card for payment. The seller then seeks its share of the gift
card proceeds from the card issuer.
Rev. Proc. 2011-18 notes that a taxpayer selling its own gift cards
and a taxpayer engaging in an indirect issuance structure should be
treated the same, and to accomplish this, Rev. Proc. 2011-18 modifies
Rev. Proc. 2004-34 to include "eligible gift card sales" in the
definition of "advance payments." "Eligible gift card sales" arise when
the issuer is primarily liable to the card holder until redemption or
expiration, and the card is redeemable by an entity legally obligated to
accept the card as payment. Rev. Proc. 2011-18 also expands Rev. Proc.
2004-34's definition of financial statement to include the financial
statement for a consolidated group. Notably, Rev. Proc. 2011-18 expands
the scope of Rev. Proc. 2004-34 only, because Treas. Reg. § 1.451-5 is
limited to taxpayers selling their own goods.
Rev. Proc. 2011-18 adds several new examples to Section 5.03 of Rev.
Proc. 2004-34, which further illustrate these new rules. Example 23
describes a corporation that operates department stores. It has several
domestic subsidiaries with which it files a consolidated return, but it
also has a foreign subsidiary that is not part of the consolidated
return. Another unrelated corporation enters into a gift card
arrangement with the consolidated group and the foreign subsidiary in
which one of the domestic subsidiaries issues gift cards redeemable by
the other domestic subsidiaries, the foreign subsidiary, or the
unrelated entity. The issuing subsidiary reimburses the entity for its
gift card sales and otherwise tracks the gift card sales and redemptions
for recognition in its financial statements. Under these facts, the
issuing subsidiary is entitled to defer the unredeemed balance of the
Example 24 describes a Subchapter S corporation that operates and
manages restaurants. It owns a partnership or equity interest in some of
the restaurants. The corporation administers a gift card program for
the group in which it and the participating restaurants issue gift cards
under the corporation's brand name that are redeemable by all
participating restaurants. All participants must honor the gift cards,
and the corporation must reimburse the restaurant for accepting the gift
cards. The corporation recognizes the payments in revenues for its
financial statements when the gift card is redeemed, and under these
facts, the corporation is entitled to defer the unredeemed amounts.
Finally, Example 25 describes a corporation operated for the benefit
of domestic and international hotel franchisees. It collects fees and
provides various services to the franchisees, including a gift card
program. The corporation receives the proceeds from the sales of the
gift cards, but it must reimburse the redeeming hotel. Because the
corporation tracks sales and redemptions, is able to determine the
recognition of revenues for its financial statements, and otherwise
meets the requirements of Rev. Proc. 2004-34, the corporation is
entitled to defer the unredeemed amounts.
Rev. Proc. 2011-18 also is effective for taxable years ending on or
after December 31, 2010. Depending on the change made, a taxpayer may
use either the automatic change procedures or the advance consent
Some have questioned the propriety of Rev. Proc. 2011-18, noting that
often gift cards are not materially different from traveler's checks.
Especially with regard to Example 25 discussed above, a commentator
noted that a card issuer who does not provide any good or service
redeemable by the gift card only has an obligation to pay money when the
card is redeemed. If treated as a traveler's check, then the money
received by the card issuer is not includable in gross income.
In general, however, both Rev. Proc. 2011-17 and Rev. Proc. 2011-18
have been welcomed by the industry for providing some clarity in this
difficult area. Numerous gift card issues remain outstanding, including
accounting for dormancy fees, treatment of cards subject to escheat, and
many other matters,11 and we will continue to follow these developments.
Rev. Proc. 2011-14
After years of adding new accounting method changes and continuing complexity in the area, Rev. Proc. 2011-1412
provides updated procedures for obtaining automatic consent for changes
in methods of accounting. It modifies Rev. Proc. 2008-5213 and Rev. Proc. 2009-3914 for automatic changes and also Rev. Proc. 97-2715 for advance consent procedures.
A key change in Rev. Proc. 2011-14 is to the definition of "under
examination," providing further accounting method change limitations.
Changes in accounting methods are not allowed while a taxpayer is under
examination. One new rule provides that the 120-day window-which
previously allowed changes in accounting methods during the 120-day
period after an examination ended, even if a subsequent examination was
begun-will end early if the Office of Appeals refers a case back to
agents for reexamination. In addition, if the Joint Committee on
Taxation is reviewing an item, the taxpayer continues to be under
examination, disallowing a method change.
Other notable changes require a copy of certain method change
requests to be filed with the IRS's Ogden, Utah, office in lieu of,
instead of in addition to, a filing with the National Office, and
special rules for audit protection. Rev. Proc. 2011-14 provides that a
taxpayer not otherwise eligible to file an accounting method change may
request a change in accounting method without audit protection if the
method to be changed is an issue under consideration by Appeals or a
For substantive changes, Rev. Proc. 2011-14 introduces several new rules and method changes, including matters with respect to:
Rev. Proc. 2011-14 is a long and very detailed document, changing
numerous areas and aspects of automatic changes in accounting methods
and advance consent for method changes. We encourage taxpayers to review
this Revenue Procedure and to consult with their tax advisors regarding
the new rules and their potential application to changes in accounting
1 Pub. L. No. 111-312 (2010).
2 Section 168(k)(2)(A).
3 See Section 168(K)(2)(E)(i).
4 See Treas. Reg. § 1.168(k)-1(b)(4)(iii)(2).
5 2011-5 I.R.B. 441.
6 2011-5 I.R.B. 443.
7 Treas. Reg. § 1.451-1(a).
8 Treas. Reg. § 1.451-5 (two years in certain
circumstances) and Rev. Proc. 2004-34, 2004-1 C.B. 991 (only until the
9 Treas. Reg. § 1.451-5(b)(1).
10 See Section 461(h), Treas. Reg. 1.461-1(a)(2)(i).
11 I.R.S. Industry Director's Directive
LMSB-04-0808-042, "Tier II Industry Director's Directive on the Planning
and Examination of Gift Card/Certificate Issues in the Retail and Food
& Beverage Industries #2" (Oct. 3, 2008).
12 2011-4 I.R.B.
13 2008-2 C.B. 587.
14 2009-38 I.R.B. 371.
15 1997-1 C.B. 680.
16 2010-49 I.R.B. 811.
The material in this publication was created as of the date set forth above and is based on laws, court decisions, administrative rulings and congressional materials that existed at that time, and should not be construed as legal advice or legal opinions on specific facts. The information in this publication is not intended to create, and the transmission and receipt of it does not constitute, a lawyer-client relationship.
This article is republished with permission of Pepper Hamilton LLP. Further duplication without the permission of Pepper Hamilton LLP is prohibited. All rights reserved.
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