I'm looking to start a business which deals in customer reward points, redeemable for giftcards/coupons/special offers, or at partner businesses. The reward point becomes a sort of currency which we are backing with a pile of cash taken from advertiser fees. This way we should always have more cash on hand than point redemption liabilities. What I need to know is how to account for the points, and how to hold the 'funds for redemption' in a way that it is not taxed (Oregon, USA) until the expense of redemption is realized, possibly multiple years. Ideally, I'd like to hold these funds in an interest-bearing account or liquid investments so we can get some output from the parked capital. Is this too complicated already? Thanks for your considerate reply! Pete
Hi, I worked for a business that does exactly what you described. I believe the answer is - you can't "park" the funds and avoid taxation of revenues you earmark for rewards cost. Rewards cost is just another cost of doing business for you.
I think the key here is that the income you recognize is not tied to points that are being redeemed. On one hand, you generate revenues from advertisers, that is your revenue, you will be taxed on the profit (in some states on revenue post some adjustments) that remains after you take out expenses (most start-ups pay state/federal minimum taxes, if any, because they are not profitable). On the other hand, every time a user earns a point, you have to book a liability on the balance sheet showing the value of the points earned but not yet redeemed. Every month, you will have to recognize an expense for Cost of Rewards, which decreases the liability. That expense hits your P&L and reduces your revenues. That is the process by which the cost of points hits the income statement, you can only recognize as an expense the cost of points that have been redeemed.
Please consider that you can institute a rule (in your T&C) that says any unused points in accounts that have been inactive for 6 months expire. Once points expire, you can reduce your liability. After approximately, 2 years, you will have enough history to also calculate breakage and reduce the points liability by a % of points that historically have not been redeemed.
I am happy to walk you through our points cost calculations. They do tend to get a little complicated.