Gift Cards and Taxes: Navigating the Details with Confidence

Gift cards offer your restaurant a wealth of benefits. Not only do they provide stabilized revenue streams; they also help spread brand awareness and boost employee morale.  

As of 2023, the global market for gift cards is valued at $984.3 billion. About 61% of customers spend more than their gift card amount (often regardless of inflation), resulting in increased revenue for the restaurant. Additionally, a business that rewards employees with gift cards often sees a spike in employee satisfaction and decreased turnover rates.  

Whether you’re just kicking off a gift card strategy for customers or rewarding employees, it’s essential that you’re familiar with the tax implications. Gift cards present a unique set of tax regulations. Your restaurant business must ensure compliance to avoid legal and financial issues.  

Luckily, we’ve collected the information you need to know. In this article, we’ll look at proper tax treatment of gift cards, reporting, compliance, and how gift cards can enhance your loyalty strategy.  

Understanding Gift Cards and Taxes 

Modern-day customers want to stretch each dollar as far as possible. Loyalty programs, including reward dollars (which are roughly the points-based equivalent of gift cards) are compelling options. When done well, gift cards can increase guest engagement. Here’s how to start setting up your gift card program to maintain compliance. 

Pro tip: According to a report from Bank of America, digital gift cards tend to contain higher amounts. In 2023, the average digital gift card held $83.95, whereas a physical gift card contained $63.86. Consider taking a mobile-first approach when developing your gift card reward program. 

Tax Treatment of Gift Card Sales 

First, let’s look at the tax treatment of gift card sales. As a business, you have two options for how you capture gift cards when reporting income:

• Recognized upon receipt (cash-basis taxpayer): This is the default method for most businesses. The income is documented when cash is received to purchase the gift card.  
• Deferral until subsequent year (accrual-basis taxpayer): If requirements under Code Section 451(c) and Reg. Sec. 1.451-8 are met, it’s possible to defer the taxes until the following year. 

Say you sell a gift card for $50, but only $25 is redeemed by the end of the tax year. The default method would require you to capture the $50 sale for that year. However, if you qualify for the regulations of Reg. Sec. 1.451-8, you may be able to defer some of the taxable income. 

In the deferred revenue option, unused cash from a sold gift card is considered a liability until redeemed or recorded as breakage.  

3 Misconceptions About Gift Card Taxation 

Given the options and complexity of gift card tax treatment, it’s easy to have misconceptions. Here are three of the most common myths around gift cards and taxation:

One:

• Myth: Income is recognized only when the gift card is redeemed. 
• Truth: A cash-basis taxpayer will report the income when a customer purchases the gift card. An accrual-basis taxpayer will recognize the income at the redemption of the gift card if it’s redeemed in the same year it was purchased. 

Two:

• Myth: All unredeemed gift cards are immediately profit-generating. 
• Truth: Every year, businesses calculate their average breakage. Breakage is the amount on a gift card a business believes will never be redeemed. This number is calculated based on historical averages. 
  

Three:

• Myth: Gift cards and comp cards are the same thing.  
• Truth: Complimentary cards and programs, or comp cards—not to be confused with the modeling industry’s composite cards—encourage customers to purchase from your business for exclusive discounts or prizes. On the other hand, gift cards contain a preloaded sum without any special reward attachments.  

What to Know About Breakage and Taxation 

Breakage is considered revenue the business gains for gift card amounts not redeemed. When companies report their annual income, they estimate the amount of breakage based on past numbers. 

For example, you sell a gift card for $50. The customer uses $20, leaving $30 remaining on the card. As the business, you remove $20 from your gift card liability and report it as revenue. The standing $30 gift card balance is marked as breakage. 

Historically, handling gift card accounting and taxes for breakage has proven challenging. In 2016, the Financial Accounting Standards Board (FASB) created a new model to reduce breakage ambiguity. The model couples historical breakage data with the ASC 606 policy, which states that a business must track gift card sales and redemption rates to gain real-time data. With this information, a company can report and estimate breakage as accurately as possible.  

Employee Gift Cards and Taxes 

2 Tax Considerations for Employee Rewards 

Rewarding employees with gift cards is a way for businesses to show their appreciation for an employee’s hard work. Yet, businesses who opt for gift card rewards should be acquainted with the related tax considerations. There are two ways to break it down:

1. De minimis fringe benefits: Additional benefits such as meal money or transportation expenses given to an employee for working overtime. They are excluded from taxable income under Revenue Code section 132(a)(4). 
2. Taxable income: Standard income, such as a gift card with funds preloaded, is given to the employee as a reward. It’s considered an additional wage and treated according to payroll taxes. 

In sum, gift cards that are rewarded to customers and redeemable for general merchandise are subject to the same regulations as taxable income. 

Pro tip: When selecting a gift card provider, consider that gift card software program's data collection and reporting. To ensure you and your staff don’t find yourselves in the middle of a regulatory nightmare, it’s important to work with companies that adhere to the latest data and reporting practices to ensure compliance with governing entities. 

Reporting and Compliance Requirements  

When you give a gift card to an employee, you must report its value as taxable income. According to the IRS, gift cards fall under the cash equivalent fringe benefit category. This means their value must be recorded as taxable income, withholding Social Security and Medicare Tax. 

Some businesses will “gross up” before running payroll. This process includes adding funds to the gift card in an amount that covers the taxes owed on that sum. So, you would calculate the taxes an employee would owe upon receiving a gift card and add that amount to the gift card. It’s the opposite of withholding taxes and deductions from the payment. In this case, the employee is responsible for paying those taxes at the end of the year.

If you opt not to gross up, you’ll report the gift card on the employee’s W2, withholding the same amount for taxes and deductions as you would for regular income. The total gift card sum lives under the boxes for wages, tips, and compensation. Generally, you’ll record gift cards as part of the employee’s wages.  

The Bottom Line 

Comprehensive Tax Compliance Tips 

Opting to reward employees with gift cards comes with a wealth of benefits. However, you must maintain compliance. Here are the key factors to keep in mind:

• Conduct regular financial audits 
• Maintain accurate record-keeping 
• Stay up to date on changing tax laws 

Consulting with Tax Professionals 

In the face of changing tax rules and regulations, working with a professional who can ensure you stay compliant may be helpful. This is especially useful if you’re a business with large-scale, complex, or automated gift card programs. 

A consultation with a tax professional allows you to get tailored advice regarding:

• Navigating the nuances of tax regulations 
• Ensuring compliance with tax laws 
• Optimizing tax obligations related to gift cards 

Working with a professional is the easiest way to ensure you avoid mistakes and remain compliant when rewarding your employees with gift cards. With the right support, you can make the most of your gift card marketing campaigns and sales, and rest assured that you’re rewarding your employees responsibly.  

Paytronix drives gift card loyalty programs all within one intuitive and cohesive platform. Contact us today for a free demo.