Accounting for Customer Loyalty Programs: Opportunities and Pitfalls

By Connie Cheng, CPA, and Colleen O’Connor, J.D., Washington, D.C.

Editor: Mary Van Leuven, J.D., LL.M.

Tax Accounting

The use of customer loyalty programs as a way of attracting and retaining customers has greatly expanded in recent years. As these loyalty programs continue to grow, so do the costs of providing loyalty rewards to customers. Thus, the federal income tax implications surrounding these programs are more relevant than ever. An often overlooked regulation may offer substantial benefits with respect to the treatment of redemption costs for taxpayers with loyalty programs.

Regs. Sec. 1.451-4 provides a method of computing net income for taxpayers that issue or sell qualifying trading stamps or premium coupons that are redeemable by that taxpayer for merchandise, cash, or other property. The regulation allows accrual-method taxpayers to subtract from gross receipts with respect to sales (of trading stamps for trading stamp companies or other items for non–trading stamp companies) an amount equal to (1) the cost of redemptions in the tax year and (2) estimated future redemptions.

Because Regs. Sec. 1.451-4 permits taxpayers to take into account the cost of future redemptions in the year the trading stamps or premium coupons are issued, applying the regulation may result in an accelerated recognition of redemption costs compared to what would otherwise be available under the general expense recognition rules of Sec. 461. Thus, for taxpayers that experience a significant lag between issuing and redeeming loyalty points, the regulation can be a beneficial method of accounting for redemption costs.

Eligibility to Use the Method

Trading stamp companies: Trading stamp companies are eligible to use this method of accounting. The Sperry and Hutchinson Co. (vendor of S&H Green Stamps, now called S&H Greenpoints) is the classic example of a trading stamp company. Taxpayers are considered trading stamp companies if:

  • The trading stamps or premium coupons are issued by purchasers to promote the sale of the purchasers’ merchandise or services;
  • The principal business activity of the taxpayer is the sale of stamps or coupons;
  • The stamps or coupons are redeemable by the taxpayer for at least one year from the date of the sale; and
  • Based on the taxpayer’s experience, no more than two-thirds of the stamps or coupons sold that are expected to be redeemed will be redeemed within six months of the date of sale (Regs. Sec. 1.451-4(a)(2)).

Non–trading stamp companies: Taxpayers that issue trading stamps or coupons with sales (rather than sell the stamps or coupons as their primary product) also may be able to use this method. For instance, a retailer may reward customers with loyalty points for buying merchandise. A customer who accumulates enough loyalty points may redeem them with the retailer for an award either specified by the retailer or chosen by the customer.

Additional requirements: Regardless of whether a taxpayer qualifies as a trading stamp company or non–trading stamp company, Regs. Sec. 1.451-4 requires that trading stamps or premium coupons be redeemable in merchandise, cash, or other property.

In addition, Regs. Sec. 1.451-4(d) requires consistency with financial reporting (meaning that a taxpayer may not take into account estimated redemptions in excess of those determined for book purposes), as well as the inclusion of certain information in the tax return.

Potentially Eligible Customer Loyalty Programs

Little recent guidance addresses the types of programs that are eligible under Regs. Sec. 1.451-4. Several older rulings have addressed the requirement that premium coupons be issued “with sales” and concluded that coupons redeemable for merchandise in the gaming context or awarded gratuitously or for past sales do not meet the “with sales” requirement (see Rev. Ruls. 74-69, 73-415, and 78-97). Likewise, the IRS has addressed the regulation’s “redeemable . . . in merchandise, cash, or other property” requirement and concluded that, when additional consideration is required to redeem coupons (e.g., a “cents-off” coupon), a customer’s right to redeem coupons is conditioned on a future purchase, making it more appropriate to match the coupon liability to that subsequent purchase (see Rev. Rul. 78-212).

The following briefly discusses the types of programs that are typical in several industries and the potential opportunities and issues involved in accounting for these programs.

Retail: Customer loyalty programs in the retail industry typically seek to reward customers for making purchases. The types of programs vary depending on the type of retailer (traditional retail store, online retailer, etc.), but generally provide (1) free merchandise (either specified by the retailer or of the customer’s choosing) when a customer’s purchases reach a certain volume (e.g., a free item after making 10 purchases), (2) discount or cents-off coupons that are earned after reaching a certain volume of purchases that can be applied to a future purchase of merchandise (e.g., $10 off a single piece of merchandise), or (3) points with a specified dollar value that can be accumulated and used to purchase merchandise of lesser, equal, or greater value.

As discussed above, the two basic requirements of Regs. Sec. 1.451-4 are that “premium coupons” must be issued with sales (assuming the taxpayer is not a trading stamp company) and must be redeemable by the taxpayer in merchandise, cash, or other property. Retailer customer loyalty programs generally meet the regulation’s “with sales” requirement because points are awarded to customers upon making a purchase and would seemingly meet the “redeemable” requirement to the extent the points are redeemable in cash, merchandise, or other property.

Typical loyalty programs that would seem to meet the regulation’s requirements are ones that allow customers to earn points with purchases and redeem accumulated points for an item of merchandise or other property of their choosing that requires no additional consideration. Alternatively, the regulation also may apply to programs under which a customer must make a certain number of purchases to receive a free item. This may include, for example, “loyalty cards” that offer a free item after the purchase of 10 similar items.

Some retailers may encounter issues with the requirement that the points be redeemable in cash, merchandise, or other property. The types of programs that are likely not to qualify in the retail context are those that provide customers cents-off coupons (i.e., a coupon issued for less than the value of the item for which it can be redeemed and that cannot be accumulated with other coupons toward the purchase of an item), even if the coupons are issued to a customer when a purchase is made. Consistent with its earlier rulings, the IRS would likely argue that the taxpayer’s right to redeem the coupon is conditioned on a future purchase, and that the coupon liability would be more appropriately matched to the subsequent sale. In that case, the appropriate treatment for the coupon liability is to take the deduction in the tax year in which the liability is fixed and determinable, and economic performance occurs under the Sec. 461 rules.

Financial services: Nowadays, a significant percentage of the taxpayers that maintain customer loyalty programs are credit card issuers. Under these programs, credit card holders earn points for using their credit cards to make purchases. The holders of these points typically can redeem them for items ranging from merchandise and gift cards from a variety of vendors to airline miles and hotel stays. The main issue for credit card issuers with respect to eligibility to use the method provided in Regs. Sec. 1.451-4 is whether they meet the “with sales” requirement, although issues may also arise with respect to whether the credit card issuer has gross receipts to which the estimated redemptions can be applied.

The use of the method provided in the regulation by a credit card issuer to estimate point redemptions was addressed in Capital One Financial Corp., 659 F.3d 316 (4th Cir. 2011), aff’g 133 T.C. 136 (2009). In that case, Capital One’s cardholders earned miles for purchases made with their credit cards. Cardholders who accumulated a certain number of miles could redeem them for an airline ticket purchased for them by Capital One. The Tax Court and the Fourth Circuit held that Capital One did not issue the points “with sales,” but, rather, it issued the points in connection with its provision of lending services.

The Fourth Circuit also noted that Capital One did not have gross receipts with respect to sales with which the points were issued, as Regs. Sec. 1.451-4 requires. Instead, it found that, while Capital One derived its gross receipts from lending services, it issued the points in connection with purchases cardholders made from merchants and other third parties. Both courts found instead that Capital One’s obligation to redeem the points was a liability and that the company met the requirements of Sec. 461 in the year it redeemed the points.

Based on the foregoing, credit card issuers face hurdles in qualifying for the regulation’s method. To the extent a credit card issuer does not engage directly in sales activity, under the IRS’s current view, the points will not meet the issued “with sales” requirement. As discussed below, credit card issuers may face an additional hurdle in meeting the redeemable in “merchandise, cash, or other property” requirement if they offer only intangibles, such as airline tickets and hotel stays, as rewards.

Hospitality and airlines: Taxpayers in the hospitality industry—including hotels, gaming establishments, and restaurants—and airlines offer points to their customers in a variety of ways. Hotels generally offer points for stays at their properties, while airlines issue points or miles for flights flown. Restaurants offer points to customers for meals purchased, and casinos and other gaming operations offer points based on gambling activity. For restaurants, the “with sales” requirement may be more easily met through the issuance of points with sales of meals. Likewise, for hotels and airlines, the “with sales” requirement may be met through the issuance of points for hotel stays and flights. However, for the gaming industry, the “with sales” requirement will be more difficult to meet if the points are earned for activities other than sales. Certain taxpayers, particularly those in the hotel and airline industries, take a different approach by operating separate trading stamp companies to meet the regulatory requirements without having to meet the “with sales” requirement imposed on non–trading stamp companies.

Even if the “with sales” or trading stamp company requirements are otherwise met, the regulation requires that the stamps or coupons issued by the taxpayer be redeemable by the taxpayer in merchandise, cash, or other property. Significantly, the use of the term “redeemable” instead of “redeemed” in connection with “merchandise, cash, or other property” suggests that the mere offering of at least one of the three options is arguably sufficient to meet this regulatory requirement. However, taxpayers who offer only “intangible” rewards, such as airline tickets, cruises, and hotel stays, may be uncertain whether the estimated costs of redeeming the items qualify for the method of accounting specified under the regulation. Guidance in other areas may support the characterization of “intangibles” as property, but taxpayers should be aware of the potential issue when considering the application of the regulation to their own facts.

Next Steps

When a taxpayer’s program qualifies, using the Regs. Sec. 1.451-4 method can be beneficial. For taxpayers not already using this method, a method change is required under the advance consent procedures of Rev. Proc. 97-27. Taxpayers should be aware, however, that the IRS National Office has not favored this method in recent years; therefore, getting a method change approved could be challenging. Of course, some taxpayers (e.g., those forming a new entity with sufficient business purpose) may be in a position to adopt permissible accounting methods.

To the extent a taxpayer’s customer loyalty program does not qualify under the regulation, the redemption liability is treated in accordance with the rules for deductions, not as an exclusion from income. In that case, the appropriate treatment is to take the redemption liability into account in the tax year in which the liability is fixed and determinable and economic performance occurs under the rules provided in Sec. 461, which generally will be in the year the customer redeems the points.

The authors would like to thank James Atkinson and Scott Vance for their comments on this item.


Mary Van Leuven is senior manager, Washington National Tax, at KPMG LLP in Washington, D.C.

For additional information about these items, contact Ms. Van Leuven at 202-533-4750 or

Unless otherwise noted, contributors are members of or associated with KPMG LLP.

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