Proper Tax and Accounting Treatment for Gift Cards and Package Credits
Wellness and longevity clinics operate on a different business model than most healthcare organizations. With retail, lifestyle, diagnostics, and health services under a single umbrella, deferred revenue is the norm. And while recurring payments from memberships and subscriptions can provide sustainable income, they come with some complexities.
Gift cards and package credits are part and parcel of the deal. As such, they must be properly accounted for to ensure accurate financial reporting and tax compliance, and also to help you measure business performance.
A Few Words About Deferred Revenue
Essentially, deferred revenue is unearned revenue. You are selling products, services, and treatments that you provide at a later date, often whenever the patient gets around to booking them.
From an accounting perspective, we treat the income as a liability. The clinic owes for these treatments until they are provided. Revenue is recognized at service delivery.
When is Revenue Earned?
With deferred revenue, there are two common scenarios:
Fixed-service packages, in which you provide a set number of sessions or treatments for a single fee. In this case, revenue is recognized proportionately as services are delivered. So, if you sell a package of 10 identical treatments for $1000, each session would be worth $100 in earnings.
Dollar-based credits are a little different because they can be applied to any service. Revenue is recognized based on the dollar value and must be deducted from the total amount paid up front.
Gift cards are similar to pre-paid packages, but are slightly different for several reasons:
They likely won’t be redeemed by the person who purchased it.
You can’t control the timing of the redemption.
Some gift cards will never be redeemed (we call this “breakage”).
For reporting purposes, you’ll record gift cards as deferred revenue until they are redeemed. But what happens if it’s not redeemed?
What You Need to Know About Breakage
If you have gift cards or other unredeemed deferred income, this is what we call breakage. And while you may think you can recognize this as income (you can in some jurisdictions), it’s not always that simple, as certain conditions must be met.
You can approach it in one of two ways:
The proportional method allows for a portion of the gift card to be recognized alongside the revenue if you expect a certain percentage of it to go unused. Calculating the breakage is often based on historical numbers.
The remote method is used when a breakage estimate is not reliable. In this case, breakage is only recognized as income when the likelihood of redemption is remote.
You should check local regulations, as they may inform how and when breakage can be recognized. In some cases, balances may have to be remitted to authorities as unclaimed property.
How This Affects Your Taxes
Tax treatment and accounting treatment don’t always align. Confusing!
In many jurisdictions, businesses are taxed on earned revenue, not the cash they receive. As a result, deferred revenue is not immediately taxable. In some cases, there may be rules accelerating income recognition for breakage if gift cards are not redeemed within a certain timeframe.
Ultimately, it’s best to work with a qualified tax professional on this, as they can advise you on what’s expected in your jurisdiction.
Sales taxes are another matter, usually applied at redemption rather than when you sell the gift card.
Service packages, however, may be taxable if the package is for a specific taxable service. In this case, taxes may be due at the time of purchase.
Understanding these distinctions is critical, as you might end up under- or overpaying taxes and creating additional administrative complexity.
Challenges to Beware, and Best Practices
Longevity clinic accounting is rarely straightforward. Clients switching between services within a package can complicate reporting and tracking credits, especially when done manually or across disconnected systems.
Additionally, if you have discounts or promos embedded in the package, or fail to track expiry dates accurately, your revenue recognition and deferred revenue balances will be inaccurate.
Here are a few tips to keep your books compliant:
Use dedicated practice management software. Your system should be able to track the following items:
Package balances
Redemption history
Expiry dates
Revenue allocation per service
Using manual methods is inefficient; the right software makes these points auditable.
Establish and enforce internal policies and define rules around the following:
Credit expiry
Refunds
Client-to-client transfers
Partial redemption
Reconcile deferred revenue monthly against:
Unused gift card balances
Unused package credits
Document your revenue recognition methodology
Clear documentation is essential for tax authorities and will help you defend against an audit.
Keep close tabs on your breakage.
When recognizing breakage income, you must have adequate historical data, a defensible strategy, and be compliant with local laws.
Strategic Implications Beyond Compliance
The way you handle deferred income isn’t just about staying compliant; it can also impact business decision-making.
For example, if you overstate deferred income, it can make your liabilities appear higher than they really are.
Conversely, if understated, you might overestimate your profits, which could at least distort cash flow metrics. If you have investors, it could be even more detrimental to the business, as your stakeholders may feel misled and lose trust.
Investors and lenders often scrutinize deferred revenue closely, as it typically foreshadows future obligations. Transparency is key to building credibility.
The Bottom Line: Revenue is Earned When Value is Delivered
Gift card and package sales are a core aspect of any longevity or wellness clinic. However, failing to provide them with the appropriate financial treatment can lead to accounting complexities and tax noncompliance.
In best practice, you must treat all prepaid amounts as deferred revenue and recognize income at service delivery. Tracking these details meticulously, along with breakage, will help you maintain accurate, defensible records and help you avoid misinterpreting your clinic’s financial position.
If you need help with this, it’s worth a quick call. Speak to the experts at Growise today!