Retailer's Loyalty Discounts Are Deductible before Being Redeemed

In Giant Eagle, 117 AFTR 2d 2016-XXXX (CA 3) the 3rd Circuit recently held that a large supermarket chain could deduct the costs of loyalty discounts even if its customers hadn't yet claimed the rewards. The taxpayer offered a loyalty “fuelperks program” that awarded gas discounts, which if unused, expired in three months. In 2006 and 2007 Giant Eagle deducted the estimated costs of redeeming a certain portion of the issued but unexpired and unredeemed fuelperks.

The IRS denied the deduction claiming that the obligation to make payment was not fixed. The Tax Court upheld, finding that the discounts became fixed when the discounts were redeemed, not when they were earned.

Under the accrual method of accounting, expenses are deductible in the first year in which

(1) All events have occurred that establish the fact of liability;

(2) The amount of the liability can be determined with reasonable accuracy; and

(3) Economic performance has occurred.

This is sometimes referred to as the "all-events test." The first two parts of the test are found in Reg. §1.461-1(a)(2). The third part is the result of the addition of Section 461(h) to the Code in 1984.

The 3rd Circuit disagreed with the IRS and the Tax Court, reasoning that Reg. 1.451-4(a)(1) allows accrual method taxpayers to deduct expenses before they were paid as long as the all events test has occurred to determine the existence of the liability and the amount of the liability could be “reasonably determined.”

Relying on in United States v. Hughes Properties, Inc., 476 U.S. 593 (1986) and Lukens Steel Co. v. Commissioner, 158 F.3d 484  (9th Cir. 1998), the 3^rd. Circuit reversed the IRS and Tax Court in determining the taxpayer's anticipated liability was fixed at year's end with reference to contract law principles. Specifically, Giant Eagle characterizes its issuance of fuelperks! rewards as a unilateral contract formed at checkout, which conferred “instant liability” on the supermarket chain to its customers for the rewards they accrued.

The dissent, citing Gold Coast Hotel & Casino v. United States, 158 F.3d 484, (9th Cir. 1998) said for purposes of the 'all events' test, what is critical is the existence of an absolute liability. Since the dissent found that after 3 months there was no liability to the card holder and furthermore there was no certainty that the point would in fact be redeemed the dissent would have denied the deduction.

If one were to focus on Treas. Reg. § 1.461-1(a)(2)(i) it provides:

Under an accrual method of accounting, a liability ... is incurred, and generally is taken into account for Federal income tax purposes, in the taxable 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. (emphasis added).

It appears that the Giant Eagle decision is at odds with case law and published regulations. What effect this 3^rd Circuit opinion will have remains to be seen.