Fees for future services. (Tax Matters).

Generally, accrual basis taxpayers include payments they receive for future services in gross income in the year of receipt. Revenue procedure 71-21, however, allows deferral of amounts a company receives in a tax year for services it will perform by the end of the following tax year.

Before 1987 American Express had included the annual fees it collected from cardholders as income in the year of receipt for both book and tax purposes. In 1987 the issuance of FASB Statement no. 91, Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans and Initial Direct Costs of Leases, required the company to prorate the annual fees for book purposes. In the same year the company asked the IRS for permission to use similar tax treatment, citing revenue procedure 71-21. The IRS denied the request, citing general counsel memorandum 39,434, which said credit card fees represented a fee paid for a property right, not a service.

In 1996 American Express filed a timely claim with the IRS for a $200,000 refund of back taxes. It subsequently sued for a refund in the U.S. Court of Federal Claims, arguing the annual fees provide cardholders with significant service-oriented benefits, such as baggage insurance and 24-hour customer service. The court disagreed, prompting the company to appeal the decision to the Federal Circuit Court of Appeals.

Result. For the IRS. American Express had argued the IRS improperly interpreted revenue procedure 71-21 when it took the position that the company's annual credit card fees were not paid for services and said the court should pay no attention to that interpretation. The Federal Circuit disagreed, holding that the IRS did not interpret a statute but rather an ambiguous term in its own revenue procedure. The court gives considerable deference to reasonable IRS interpretations of those rulings.

American Express also argued that two previous Tax Court decisions supported the argument that its credit card fees represented amounts paid for services, since the company gave cardholders prorated refunds when they canceled the card during the year. In Barnett Banks of Florida, Inc. v. Commissioner, 106 TC 103, the bank's credit card agreement permitted a partial refund of the annual fee upon cancellation based on the number of months the customer had used the card. Lost cards were replaced free and cardholders had 24-hour access to Barnett's customer service department. The Tax Court held that the IRS abused its discretion when it denied Barnett the opportunity to defer the credit card fees since the bank was obligated to provide significant services after granting the card.

In Signet Banking Corp. v. Commissioner, 106 TC 117, under the cardholder agreement the bank's annual fees were nonrefundable. The agreement also said the annual fee was to open the account and set a credit limit. The Tax Court held that the IRS had not abused its discretion when it did not permit Signet to defer income since the bank was not required to provide future services. The Federal Circuit rejected the Tax Court's conclusions, stating that neither the credit card agreement terms nor the fee's refundability should determine whether the granting of credit is a service.

It appears the Federal Circuit would have considered an argument to defer a portion of the fees. The court's decision to allow no deferral was in part because American Express did not argue it was possible to allocate fees between service and nonservice portions. The company had originally attempted such an allocation but the IRS refused to accept it.

* American Express Company and Affiliated Subsidiaries v. United States, 2001-2 USTC 50,596.

Prepared by Charles J. Reichert, CPA, CIA, professor of accounting at the University of Wisconsin in Superior.