May 8, 2024

A Giant Eagle rematch? IRS Chief Counsel reiterates its disagreement with Third Circuit’s interpretation of all-events test

Kristen Martin, Ellen McElroy, Brighid O'Donoghue, Michael Resnick

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Eversheds Sutherland (US) LLP

On April 26, 2024, IRS Chief Counsel, Income Tax & Accounting (IT&A), released a legal memorandum (ILM) addressing the treatment of credit card reward liabilities for which a customer earns rewards that can be redeemed for cash, statement credits, gift cards, or other goods and services.

Specifically, IRS Chief Counsel concluded that credit card reward liabilities become fixed and determinable under section 461 once the cardholder has the right to redeem the rewards for cash or a statement credit. Economic performance occurs under section 461(h) when reward payments are made to cardholders in the form of cash, a statement credit, or other goods or services. Finally, IRS Chief Counsel concluded credit card issuers may adopt the recurring item exception under Treas. Reg. section 1.461-5 to deduct credit card reward liabilities in the year in which they become fixed and determinable to the extent such rewards are redeemed by cardholders within 8 ½ months after the close of such taxable year.

The taxpayer discussed in the ILM is a federally chartered bank that issues credit cards and allows cardholders to earn rewards points for purchases made with the credit card. However, the principles addressed in the ILM are broadly applicable to other industries that issue reward points. At issue in the ILM were points redeemable for cash, statement credit, or goods or services, as chosen by the cardholder, immediately upon receipt with no further purchase required. IRS personnel requested Chief Counsel’s advice as to whether such a taxpayer could apply the recurring item exception to deduct the credit card rewards liabilities in the taxable year in which cardholders earn the reward, provided the rewards are redeemed within 8 ½ months after such year end.

Generally, an accrual method taxpayer must take a liability into account 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 (All-Events Test). The ILM references United States v. General Dynamics, 481 U.S. 239 (1987), as support for its longstanding position that the All-Events Test is not satisfied if there remains a non-ministerial condition precedent that must be satisfied before the liability is fixed. Per the ILM, a requirement that a customer must make an additional purchase to redeem a reward is such a condition precedent.

IRS Chief Counsel took the opportunity in its analysis to reiterate its disagreement with the Third Circuit’s decision in Giant Eagle, Inc. v. Commissioner, 822 F.3d 666 (3d Cir. 2016), rev’g T.C. Memo 2014-146, AOD-2016-03 (2017), I.R.B. 2016-40, in which the Third Circuit determined that liabilities related to a rewards program, which provided a $0.10 per gallon discount on gasoline for every $50 spent on groceries, were fixed in the year earned, regardless of the fact that redemption of the gasoline discount would require an additional purchase – the purchase of gasoline – and expired after 3 months of non-use. Importantly, the Third Circuit reversed the Tax Court, finding that rewards points could be deducted by the taxpayer even if they remained outstanding at year-end.

Eversheds Sutherland Observation: At issue in the ILM, the credit card rewards are immediately redeemable with no condition precedent. Chief Counsel nevertheless notes that credit card reward programs that do not provide cash or statement credit redemption options, but require an additional purchase to receive a partial or complete discount, include a condition precedent such that the liabilities are not “fixed” for purposes of the All-Events Test. Thus, while Chief Counsel views the rewards liabilities in the ILM as satisfying the “fixed” prong of the All-Events Test when they are earned by cardholders, this conclusion does not signal a departure from its Giant Eagle AOD. Notably, at the recent ABA Tax Section May Meeting, Ron Goldstein, IRS Office of Chief Counsel, IT&A, who authored the ILM, suggested that his office feels so strongly about the position in the AOD that, should the issue come up outside of the Third Circuit, it would likely pursue litigation consistent with the AOD. Apparently, the IRS sees a distinction between reward programs that require additional action by the customer for redemption (e.g., when there is a condition precedent to redemption), and when no additional action is required. In this regard, the IRS relies on United States v. General Dynamics Corp., 481 U.S. 239 (1987). Under the IRS view, if the taxpayer must wait for the condition precedent to occur, the taxpayer is not entitled to a deduction until the customer redeems the reward.

In the ILM, Chief Counsel also concludes that credit card points that are redeemable for cash, a statement credit, or other goods or services constitute “a rebate, refund, or similar payment” for purposes of Treas. Reg. section 1.461-4(g)(3) because, ultimately, the cardholder receives cash back or other rewards the amount of which is determined by the purchase price of purchases made with the credit card. Thus, economic performance for credit card reward liabilities is satisfied when the redemption payment is made (i.e., when the points are redeemed by the cardholder). Finally, IRS Chief Counsel concluded the credit card reward liabilities are eligible for the recurring item exception to the extent points are redeemed within 8 ½ months of the end of the taxable year in which the points are earned by cardholders.

Eversheds Sutherland Observation: Many industries employ reward programs to encourage consumers to buy or use products. While the ILM discusses reward program structures that are common to banks and credit card companies, it will be of interest to companies in other industries (e.g., airlines, hotels, restaurants) that use loyalty or other points-based rewards programs. Taxpayers outside of the Third Circuit should take note of the IRS’s strong stance on its Giant Eagle AOD, and understand that the IRS views any non-ministerial condition precedent as a blocker to satisfying the fixed prong of the All-Events Test under section 461. While the ILM provides helpful illustration of how the All-Events Test applies to reward program liabilities, it also serves as a statement and a reminder that the IRS maintains its disagreement with the Third Circuit’s 2016 decision in Giant Eagle.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.