Taxation of Rewards Programs
A recent US Tax Court case illustrates how the taxation of hotel rewards programs, gift cards, or points programs could be a potential tax trap for the unwary. In Hyatt Hotels Corp v. Comm’r (TC Memo 2023-122), the Hyatt hotel chain ended up with a hefty assessment as a result of its hotel points program. Learn more about the taxation of rewards programs.
In the Hyatt Hotels case, the participating hotels had a points program where guests could earn points, they could exchange for hotel stays and airplane tickets. (Some of these hotels were owned by Hyatt and others were owned by third parties.) The participating hotels would pay into a fund administered by Hyatt each time guests earned points by staying at their hotel. When a guest used their points at a particular hotel, the fund would compensate the hotel. Hyatt invested the money contributed into the fund and also used the fund for administrative fees and advertising.
The Tax Court’s decision was harsh on Hyatt’s Rewards Program fund. Hyatt determined the fund recognized income every time participating hotels contributed to the fund. The court also determined the fund could not recognize any taxable deductions until it actually reimbursed hotels.
According to the Tax Court, the Hyatt Rewards Program fund went wrong because the arrangement it had with participating hotels gave it too much control over the money it received from the hotels. As a general rule, a business that receives money or anything of value recognizes taxable income. One of the narrow exceptions that could apply to a business running a points program is the trust fund doctrine. Under the trust fund doctrine, a taxpayer, like a business running a rewards program, would not recognize income when it received money that is held in trust. This requires a showing that the party who receives the money is (1) legally restricted in how it uses the money and (2) does not benefit from its use of the money.
Hyatt failed this test because it did not appear to have any legal restrictions on how it used its money. It used points for investment, advertising, and administrative costs. The participating hotels had little input into how Hyatt used the money. Hyatt also benefitted from its use of the money. Among other things, it profited from its investments.
Next, Hyatt was not able to claim deductions until it paid the participating hotels. Accrual based taxpayers can claim a deduction when “all events have occurred that establish the fact of the liability.” Points programs fail this test when a customer earns points because it is not yet certain how or if the customer will use the points. There is a trading stamp accounting method that creates a narrow exception to the “all events” test, but according to the Tax Court in Hyatt, the trading stamp method could only be used for tangible goods and merchandise. According to the Tax Court, the trading stamp method could not be used for hotel rooms because hotel rooms are a service and not a tangible good or tangible merchandise.
Gift cards, point programs, and other similar programs can be a potential trap for taxpayers. A business may be forced to recognize income when it receives income from the program but may not be able to take any offsetting deductions until the points or gift cards are redeemed.
RJS Law helps clients will a wide range of tax problems from tax controversy, international tax, tax planning, audits, and estate planning. Call us at 619-595-1655 or on the web at RJS LAW for a free consultation if you are experiencing any type of tax problem.
Written by Joseph Cole, Esq., LL.M.