Credit card issuers who continue to charge annual fees should pay attention to two recent court rulings, a Big Six accounting firm suggests.
The rulings, handed down Feb. 29 by the U.S. Tax Court in cases involving Barnett Banks of Florida and Signet Banking Corp., determine whether annual fees can be deferred for federal income tax purposes.
Arthur Andersen & Co. said the impact of the rulings on issuers will depend on the language used in their credit card agreements and the accounting method being used for tax purposes.
In the Barnett Bank case, the Tax Court held that annual fees paid to the bank by cardholders were payments for services, and that the bank could account for the fees on a proportional basis over a 12-month credit card agreement period.
"The annual fee was paid for services and was refundable to the cardholder on a pro rata basis if the card was canceled for any reason during the one-year period," the court noted.
By contrast, the Tax Court held that Signet must report annual credit card membership fees in taxable income in the year of receipt. The court noted that in Signet's cardholder agreement, the credit card fee "is nonrefundable and is paid in consideration of issuance of the card and establishment of a credit limit."
Based on those two facts, the Tax Court said Signet must recognize the fee income up front and cannot defer it, said Mary B. Doyle, a tax manager for Arthur Andersen in Washington. In Barnett's case, the bank can defer the fee income over the course of the agreement.
Tax accounting generally requires that payments received for services to be performed in the future must be included in gross income in the year of receipt, Ms. Doyle said. If a taxpayer receives a payment in one taxable year for services that will be performed before the end of the following taxable year, the taxpayer may include the advance payment in gross income as the services are provided.
"By modeling the agreement after the language in the Barnett agreement," Ms. Doyle said, "(banks) have a better chance of deferring any income over the life of the agreement and putting the IRS off from being able to come in and say, 'Nope, you've got to tax it up front because you earned it today - it's not refundable, and it clearly says here in your agreement that it's paid for the issuance of the card.'"