[Code of Federal Regulations] [Title 26, Volume 6] [Revised as of April 1, 2004] From the U.S. Government Printing Office via GPO Access [CITE: 26CFR1.451-4] [Page 111-115] TITLE 26--INTERNAL REVENUE CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY (CONTINUED) PART 1_INCOME TAXES--Table of Contents Sec. 1.451-4 Accounting for redemption of trading stamps and coupons. (a) In general--(1) Subtraction from receipts. If an accrual method taxpayer issues trading stamps or premium coupons with sales, or an accrual method taxpayer is engaged in the business of selling trading stamps or premium coupons, and such stamps or coupons are redeemable by such taxpayer in merchandise, cash, or other property, the taxpayer should, in computing the income from such sales, subtract from gross receipts with respect to sales of such stamps or coupons (or from gross receipts with respect to sales with which trading stamps or coupons are issued) an amount equal to-- (i) The cost to the taxpayer of merchandise, cash, and other property used for redemptions in the taxable year, (ii) Plus the net addition to the provision for future redemptions during the taxable year (or less the net subtraction from the provision for future redemptions during the taxable year). (2) Trading stamp companies. For purposes of this section, a taxpayer will be considered as being in the business of selling trading stamps or premium coupons if-- [[Page 112]] (i) The trading stamps or premium coupons sold by him are issued by purchasers to promote the sale of their merchandise or services, (ii) The principal activity of the trade or business is the sale of such stamps or coupons, (iii) Such stamps or coupons are redeemable by the taxpayer for a period of at least 1 year from the date of sale, and (iv) Based on his overall experience, it is estimated that not more than two-thirds of the stamps or coupons sold which it is estimated, pursuant to paragraph (c) of this section, will be ultimately redeemed, will be redeemed within 6 months of the date of sale. (b) Computation of the net addition to or subtraction from the provision for future redemptions--(1) Determination of the provision for future redemptions. (i) The provision for future redemptions as of the end of a taxable year is computed by multiplying ``estimated future redemptions'' (as defined in subdivision (ii) of this subparagraph) by the estimated average cost of redeeming each trading stamp or coupon (computed in accordance with subdivision (iii) of this subparagraph). (ii) For purposes of this section, the term ``estimated future redemptions'' as of the end of a taxable year means the number of trading stamps or coupons outstanding as of the end of such year that it is reasonably estimated will ultimately be presented for redemption. Such estimate shall be determined in accordance with the rules contained in paragraph (c) of this section. (iii) For purposes of this section, the estimated average cost of redeeming each trading stamp or coupon shall be computed by including only the costs to the taxpayer of acquiring the merchandise, cash, or other property needed to redeem such stamps or coupons. The term ``the costs to the taxpayer of acquiring the merchandise, cash, or other property needed to redeem such stamps or coupons'' includes only the price charged by the seller (less trade or other discounts, except strictly cash discounts approximating a fair interest rate, which may be deducted or not at the option of the taxpayer provided a consistent course is followed) plus transportation or other necessary charges in acquiring possession of the goods. Items such as the costs of advertising, catalogs, operating redemption centers, transporting merchandise or other property from a central warehouse to a branch warehouse (or from a warehouse to a redemption center), and storing the merchandise or other property used to redeem stamps or coupons should not be included in costs of redeeming stamps or premium coupons, but rather should be accounted for in accordance with the provisions of sections 162 and 263. (2) Changes in provision for future redemptions. For purposes of this section, a ``net addition to'' or ``net subtraction from'' the provision for future redemptions for a taxable year is computed as follows: (i) Carry over the provision for future redemptions (if any) as of the end of the preceding taxable year, (ii) Compute the provision for future redemptions as of the end of the taxable year in accordance with subparagraph (1) of this paragraph, and (iii) If the amount referred to in subdivision (ii) of this subparagraph exceeds the amount referred to in subdivision (i) of this subparagraph, such excess is the net addition to the provision for future redemptions for the taxable year. On the other hand, if the amount referred to in such subdivision (i) exceeds the amount referred to in such subdivision (ii), such excess is the net subtraction from the provision for future redemptions for the taxable year. (3) Example. The provisions of this paragraph and paragraph (a)(1) of this section may be illustrated by the following example: Example. (a) X Company, a calendar year accrual method taxpayer, is engaged in the business of selling trading stamps to merchants. In 1971, its first year of operation, X sells 10 million stamps at $5 per 1,000; it redeems 3 million stamps for merchandise and cash of an average value of $3 per 1,000 stamps. At the end of 1971 it is estimated (pursuant to paragraph (c) of this section) that a total of 9 million stamps of the 10 million stamps issued in 1971 will eventually be presented for redemption. At this time it is estimated that the average cost of redeeming stamps (as described in subparagraph (1)(iii) of this paragraph) would continue to [[Page 113]] be $3 per 1,000 stamps. Under these circumstances, X computes its gross income from sales of trading stamps as follows: Gross receipts from sales (10 million stamps at $5 ........ $50,000 per 1,000)......................................... Less: Cost of actual redemptions (3 million stamps at $3 $9,000 ........ per 1,000)....................................... Provision for future redemptions on December 31, 18,000 ........ 1971 (9 million stamps -- 3 million stamps x $3 per 1,000)....................................... ---------- ........ 27,000 --------- 1971 gross income from sales of stamps.............. ........ 23,000 (b) In 1972, X also sells 10 million stamps at $5 per 1,000 stamps. During 1972 X redeems 7 million stamps at an average cost of $3.01 per 1,000 stamps. At the end of 1972 it is determined that the estimated future redemptions (within the meaning of subparagraph (1)(ii) of this paragraph) is 8 million. It is further determined that the estimated average cost of redeeming stamps would continue to be $3.01 per 1,000 stamps. X thus computes its gross income from sales of trading stamps for 1972 as follows: Gross receipts from sales (10 million stamps at $5 per 1,000). $50,000 Less: Cost of actual redemptions (7 million stamps at $21,070 ........ $3.01 per 1,000)................................. Plus: Provision for future redemptions on Dec. 31, 1972 24,080 ........ (8 million stamps at $3.01 per 1,000)............ Minus provision for future redemptions on Dec. 31, 18,000 ........ 1971............................................... ---------- Addition to provision for future redemptions........ 6,080 ........ ---------- Total cost of redemptions.................................. 27,150 --------- 1972 Gross income from sales of stamps.............. ........ 22,850 (c) Estimated future redemptions--(1) In general. A taxpayer may use any method of determining the estimated future redemptions as of the end of a year so long as-- (i) Such method results in a reasonably accurate estimate of the stamps or coupons outstanding at the end of such year that will ultimately be presented for redemption, (ii) Such method is used consistently, and (iii) Such taxpayer complies with the requirements of this paragraph and paragraphs (d) and (e) of this section. (2) Utilization of prior redemption experience. Normally, the estimated future redemptions of a taxpayer shall be determined on the basis of such taxpayer's prior redemption experience. However, if the taxpayer does not have sufficient redemption experience to make a reasonable determination of his ``estimated future redemptions,'' or if because of a change in his mode of operation or other relevant factors the determination cannot reasonably be made completely on the basis of the taxpayer's own experience, the experiences of similarly situated taxpayers may be used to establish an experience factor. (3) One method of determining estimated future redemptions. One permissible method of determining the estimated future redemptions as of the end of the current taxable year is as follows: (i) Estimate for each preceding taxable year and the current taxable year the number of trading stamps or coupons issued for each such year which will ultimately be presented for redemption. (ii) Determine the sum of the estimates under subdivision (i) of this subparagraph for each taxable year prior to and including the current taxable year. (iii) The difference between the sum determined under subdivision (ii) of this subparagraph and the total number of trading stamps or coupons which have already been presented for redemption is the estimated future redemptions as of the end of the current taxable year. (4) Determination of an ``estimated redemption percentage.'' For purposes of applying subparagraph (3)(i) of this paragraph, one permissible method of estimating the number of trading stamps or coupons issued for a taxable year that will ultimately be presented for redemption is to multiply such number of stamps issued for such year by an ``estimated redemption percentage.'' For purposes of this section the term ``estimated redemption percentage'' for a taxable year means a fraction, the numerator of which is the number of trading stamps or coupons issued during a taxable year that it is reasonably estimated will ultimately be redeemed, and the denominator of which is the number of trading stamps or coupons issued during such year. Consequently, the product of such percentage and the number of stamps [[Page 114]] issued for such year equals the number of trading stamps or coupons issued for such year that it is estimated will ultimately be redeemed. (5) Five-year rule. (i) One permissible method of determining the ``estimated redemption percentage'' for a taxable year is to-- (a) Determine the percentage which the total number of stamps or coupons redeemed in the taxable year and the 4 preceding taxable years is of the total number of stamps or coupons issued or sold in such 5 years; and (b) Multiply such percentage by an appropriate growth factor as determined pursuant to guidelines published by the Commissioner. (ii) If a taxpayer uses the method described in subdivision (i) of this subparagraph for a taxable year, it will normally be presumed that such taxpayer's ``estimated redemption percentage'' is reasonably accurate. (6) Other methods of determining estimated future redemptions. (i) If a taxpayer uses a method of determining his ``estimated future redemptions'' (other than a method which applies the 5-year rule as described in subparagraph (5)(i) of this paragraph) such as a probability sampling technique, the appropriateness of the method (including the appropriateness of the sampling technique, if any) and the accuracy and reliability of the results obtained must, if requested, be demonstrated to the satisfaction of the district director. (ii) No inference shall be drawn from subdivision (i) of this subparagraph that the use of any method to which such subdivision applies is less acceptable than the method described in subparagraph (5)(i) of this paragraph. Therefore, certain probability sampling techniques used in determining estimated future redemptions may result in reasonably accurate and reliable estimates. Such a sampling technique will be considered appropriate if the sample is-- (a) Taken in accordance with sound statistical sampling principles, (b) In accordance with such principles, sufficiently broad to produce a reasonably accurate result, and (c) Taken with sufficient frequency as to produce a reasonably accurate result. In addition, if the sampling technique is appropriate, the results obtained therefrom in determining estimated future redemptions will be considered accurate and reliable if the evaluation of such results is consistent with sound statistical principles. Ordinarily, samplings and recomputations of the estimated future redemptions will be required annually. However, the facts and circumstances in a particular case may justify such a recomputation being taken less frequently than annually. In addition, the Commissioner may prescribe procedures indicating that samples made to update the results of a sample of stamps redeemed in a prior year need not be the same size as the sample of such prior year. (d) Consistency with financial reporting--(1) Estimated future redemptions. For taxable years beginning after August 22, 1972, the estimated future redemptions must be no greater than the estimate that the taxpayer uses for purposes of all reports (including consolidated financial statements) to shareholders, partners, beneficiaries, other proprietors, and for credit purposes. (2) Average cost of redeeming stamps. For taxable years beginning after August 22, 1972, the estimated average cost of redeeming each stamp or coupon must be no greater than the average cost of redeeming each stamp or coupon (computed in accordance with paragraph (b)(1)(iii) of this section) that the taxpayer uses for purposes of all reports (including consolidated financial statements) to shareholders, partners, beneficiaries, other proprietors, and for credit purposes. (e) Information to be furnished with return--(1) In general. For taxable years beginning after August 22, 1972, a taxpayer described in paragraph (a) of this section who uses a method of determining the ``estimated future redemptions'' other than that described in paragraph (c)(5)(i) of this section shall file a statement with his return showing such information as is necessary to establish the correctness of the amount subtracted from gross receipts in the taxable year. (2) Taxpayers using the 5-year rule. If a taxpayer uses the method of determining estimated future redemptions [[Page 115]] described in paragraph (c)(5)(i) of this section, he shall file a statement with his return showing, with respect to the taxable year and the 4 preceding taxable years-- (i) The total number of stamps or coupons issued or sold during each year, and (ii) The total number of stamps or coupons redeemed in each such year. (3) Trading stamp companies. In addition to the information required by subparagraph (1) or (2) of this paragraph, a taxpayer engaged in the trade or business of selling trading stamps or premium coupons shall include with the statement described in subparagraph (1) or (2) of this paragraph such information as may be necessary to satisfy the requirements of paragraph (a)(2)(iv) of this section. [T.D. 7201, 37 FR 16911, Aug. 23, 1972, as amended by T.D. 7201, 37 FR 18617, Sept. 14, 1972]