The gift card sits in millions of wallets and purses across America, a small rectangle of promise and future purchase. Over 77% of consumers buy at least one during the holiday season, yet the sales tax rules governing these ubiquitous slips of stored value remain murky to most who handle them. The truth is simpler than the confusion suggests: sales tax doesn’t touch the card when you buy it, but waits patiently for the moment of redemption.
The initial sale of gift cards and certificates is generally not subject to sales tax because the purchaser is not buying a tangible product or service at that moment. They are acquiring a tool for future transactions, so a claim on goods yet unchosen. This means if you purchase a $100 gift card, you should only pay $100, not $100 plus sales tax. Unfortunately, many retailers continue to charge sales tax at the point of purchase, leading to customer confusion and the quiet sting of double taxation.
If you operate a retail business selling gift cards across multiple states and need clarity on proper sales tax treatment, HOST provides comprehensive compliance support tailored to multi-channel retailers.
Purchase vs. Redemption: Where Tax Is Actually Applied
Understanding the distinction between purchase and redemption is critical for maintaining sales tax compliance. When a customer purchases a gift card, no sales tax applies. The sales tax obligation arises only when the gift card is redeemed for actual goods or services.
At the Point of Purchase
At the point of purchase, gift cards should never be subject to sales tax. A gift card is not considered goods for sale; instead, it is a purchase meant to be used for payment in the future. Retailers who charge sales tax at the time of gift card purchase are violating standard sales tax regulations in most jurisdictions.
If you’ve been charged sales tax on a gift card purchase, you have the right to request a refund and should bring the matter to the retailer’s attention. The error is common enough that many point-of-sale systems incorrectly apply tax by default.
At the Point of Redemption
Sales tax becomes applicable when the gift card is redeemed to purchase taxable items. The sales tax is calculated on the full selling price of the items purchased, not on any discounted amount.
For example, if a customer redeems a $50 gift card toward a $70 purchase of taxable merchandise, sales tax is calculated on the full $70, then the $50 gift card is applied to reduce the customer’s cash payment. The state cares about the value of what’s being sold, not the method of payment used.
State-by-State Variations and Considerations
While most states follow the same basic principle: no tax at purchase, tax at redemption, variations exist that retailers must monitor. State laws continue to evolve regarding gift card regulations, including provisions for cash-back policies, expiration dates, and escheatment requirements.
Digital vs. Physical Gift Cards
Digital gift cards are becoming increasingly prevalent, bringing new compliance challenges. When a digital gift card is purchased online, retailers must determine which state’s tax laws apply. This becomes particularly complex when the purchaser, recipient, and retailer are located in different states or jurisdictions.
Additionally, gift cards for digital goods may be treated differently than general merchandise gift cards. For instance, some states tax gift cards for digital goods at the time of purchase, unlike traditional gift card sales. Retailers must research and stay current with state-specific rules regarding digital goods taxation.
Multi-Use vs. Single-Use Gift Cards
The type of gift card can significantly impact how sales tax is managed. Multi-use gift cards, which can be used for multiple purchases, complicate tax tracking as retailers must record each transaction accurately and apply sales tax correctly every time.
Single-use gift cards simplify the calculation and management of sales tax since the tax process is completed once the card is redeemed. The card exhausts itself in a single transaction, and the tax obligation closes with it.
Unclaimed Property and Escheatment Laws
Beyond immediate sales tax considerations, retailers must understand escheatment laws that apply when gift cards remain unused. These laws mean that when a gift card is abandoned or unused for a certain amount of time, the state can charge the vendor sales tax on that amount or a percentage of it.
All 50 states plus the District of Columbia have adopted unclaimed property or escheatment laws for intangible property held by companies. A company that holds unclaimed property must report and remit it to the applicable state once it has remained unclaimed for the statutorily required period, typically three to five years.
States typically impose penalties and interest for unclaimed property that isn’t reported or is reported late. The forgotten gift card in the drawer becomes the state’s concern after enough time passes.
Marketplace Facilitator Laws and Third-Party Platforms
Many gift cards are sold through third-party platforms, adding another layer of complexity. Marketplace facilitator laws in some states require marketplace platforms to collect and remit sales tax on behalf of third-party sellers.
Retailers using third-party platforms must understand their tax collection and remittance responsibilities to avoid compliance issues. In some jurisdictions, the marketplace platform itself may be responsible for collecting and remitting sales tax, while in others, the individual retailer retains that responsibility. This distinction is crucial for proper compliance and accurate tax reporting.
If your business sells gift cards through multiple channels including marketplaces like Amazon or eBay, HOST can help you navigate which entity bears responsibility for tax collection in each jurisdiction.
Best Practices for Gift Card Tax Compliance
To maintain proper sales tax compliance with gift card sales and redemptions, retailers should implement the following practices.
Invest in Advanced Point-of-Sale Systems
Sophisticated point-of-sale (POS) and accounting systems that accurately track gift card sales, redemptions, and related sales tax liabilities are essential. These systems help ensure accurate tax calculation and maintain the detailed records necessary for audits and compliance verification.
The right technology prevents errors before they compound into audit triggers.
Establish Clear Gift Card Policies
Businesses should develop well-defined policies for handling returns, exchanges, and unused gift cards. These policies must align with sales tax regulations to avoid inconsistencies that could lead to compliance issues.
Documentation of these policies should be readily available to employees and customers. When everyone knows the rules, fewer mistakes slip through.
Stay Updated on Regulatory Changes
Tax regulations are frequently updated, particularly those related to digital transactions and marketplace facilitator laws. Staying current with changes will help your business adapt its compliance strategies effectively and avoid penalties for non-compliance.
Rather than tracking regulatory changes yourself, consider HOST’s ongoing compliance monitoring to ensure your gift card program stays compliant as laws evolve.
Common Mistakes to Avoid
Retailers frequently make costly errors when handling gift card sales tax. The most common mistake is charging sales tax at the time of gift card purchase rather than at redemption. This not only violates sales tax regulations but also damages customer relationships and can trigger audits.
Another common error involves improper tracking of multi-use gift cards. Failing to accurately record each transaction or apply sales tax correctly to different redemptions can result in significant tax compliance issues. Additionally, overlooking state-specific rules regarding digital gift cards can lead to unexpected tax liabilities that arrive without warning, like bills for obligations you didn’t know existed.
How HOST Simplifies Gift Card Tax Compliance
Gift card sales tax compliance requires careful tracking across purchase, redemption, and escheatment phases. Between state-specific variations, marketplace facilitator rules, and evolving digital goods taxation, maintaining accuracy without expert help becomes increasingly difficult.
Hands Off Sales Tax (HOST) specializes in retail compliance, offering multi-state registrations, ongoing filings, and custom tax matrix development for businesses managing gift card programs across state lines.
Whether you’re a small retailer expanding into e-commerce or a multi-channel business managing gift card sales through physical stores, online platforms, and third-party marketplaces, HOST provides the clarity and compliance support you need.
Frequently Asked Questions (FAQ)
Do I need to pay sales tax when I purchase a gift card?
No. In all U.S. states, sales tax does not apply to the purchase of gift cards themselves. Sales tax should only be charged when the gift card is redeemed for goods or services. If a retailer charges you sales tax on a gift card purchase, you should request a refund.
The reasoning is straightforward: at the moment of purchase, you haven’t actually bought any goods or services yet, you’ve simply prepaid for a future transaction. The sales tax obligation waits dormant until the card holder selects and purchases actual merchandise.
When exactly should sales tax be collected on a gift card redemption?
Sales tax should be collected when the customer uses the gift card to make a purchase. The tax is calculated on the full selling price of the items being purchased, applied before the gift card amount is deducted from the total.
This means if someone buys a $100 item and pays with a $50 gift card plus $50 cash, the sales tax is calculated on the full $100 transaction value. The gift card functions as a payment method, not as a discount that reduces the taxable base.
Unsure how to configure your POS system to handle gift card redemptions correctly? HOST can review your sales tax setup and ensure proper tax application across all transaction types.
How should I handle sales tax if a customer uses a gift card for both taxable and non-taxable items?
The gift card value should be proportionally applied to both taxable and non-taxable items, or applied using any reasonable, consistent method based on your books and records. Sales tax is calculated only on the taxable portion of the sale.
For example, if a customer purchases $60 in taxable clothing and $40 in non-taxable groceries (in states where groceries are exempt), and pays with a $50 gift card, you would apply $30 of the gift card to the clothing and $20 to the groceries proportionally. Sales tax applies only to the $60 in clothing, regardless of how payment is split.
Alternatively, some retailers apply gift cards to non-taxable items first to minimize tax collection complexity, as long as you apply a consistent methodology and document it properly.
Are digital gift cards treated differently for sales tax purposes?
Generally, digital gift cards follow the same sales tax rules as physical gift cards. However, gift cards for digital goods may be treated differently in some states and may be taxed at the time of purchase rather than redemption. Always verify state-specific regulations.
The distinction becomes critical when dealing with closed-loop digital gift cards (usable only for specific digital products like streaming services, downloadable games, or software). Some states classify these as prepaid access to taxable digital goods and assess tax immediately at purchase rather than waiting for redemption.
Additionally, sourcing rules for digital gift cards can vary. Some states tax based on the purchaser’s location, others based on where the recipient redeems the card. This creates particular complexity for businesses selling digital gift cards nationally.
What happens if a gift card is never redeemed?
If a gift card remains unused for a specified period (typically 3-5 years depending on state law), it becomes subject to unclaimed property laws. The retailer may be required to report and remit the value to the state, potentially including sales tax obligations.
This process, known as escheatment, requires businesses to turn over the unredeemed value to the state’s unclaimed property division. Each state sets its own dormancy period: the length of time before a gift card is considered abandoned. Some states require remittance after three years, others after five.
Importantly, even though sales tax wasn’t collected at purchase, some states may require you to remit sales tax on escheated amounts. The logic is that the state is receiving funds that would have generated sales tax revenue if redeemed normally.
Do I need to charge sales tax differently for gift cards sold through a third-party marketplace?
It depends on whether your state has enacted marketplace facilitator laws. In some states, the marketplace platform is responsible for collecting and remitting sales tax, while in others, the individual retailer retains that responsibility. Research your specific state’s requirements.
For gift cards specifically, the situation becomes more nuanced. If you sell your company’s gift cards through Amazon or another marketplace, the marketplace typically handles tax collection on the items eventually purchased with those gift cards, but only if those items are also sold through that same marketplace.
If a customer buys your gift card on Amazon but redeems it at your physical store or independent website, you maintain responsibility for proper sales tax collection at redemption. This split responsibility requires careful tracking to avoid compliance gaps.
Can expired gift card balances create tax liabilities?
Yes. Some states require retailers to report unredeemed gift card values as unclaimed property if they expire or go unused. This can result in sales tax obligations even on balances that were never actually used for purchases.
However, it’s worth noting that many states now prohibit gift card expiration dates entirely under consumer protection laws. Federal regulations under the Credit CARD Act of 2009 require gift cards to remain valid for at least five years from purchase or last reload date.
When escheatment occurs, the tax treatment varies by state. Some states allow retailers to remit the unredeemed value without assessing sales tax. Others require sales tax remittance as if the card had been redeemed for taxable goods. Still others calculate tax based on your historical ratio of taxable to non-taxable sales.
How should I account for gift card “breakage” (unused balances) for tax purposes?
Breakage accounting has become more standardized since 2016 when the Financial Accounting Standards Board created new guidelines. Businesses should track historical breakage data and redemption rates to estimate and report breakage as accurately as possible while maintaining compliance.
From a sales tax perspective, breakage creates complexity because you must determine whether unredeemed amounts will eventually be subject to sales tax (through redemption) or escheatment requirements (through abandonment). Most states don’t require sales tax remittance on breakage until one of these two events occurs.
For accounting purposes, businesses can recognize breakage revenue proportionally as gift cards are redeemed, based on historical redemption patterns. For example, if data shows that 10% of gift cards are never redeemed, you can recognize that 10% as breakage income as cards are used. However, this accounting treatment doesn’t trigger immediate sales tax obligations in most jurisdictions.
What should I do if I’ve been incorrectly charging sales tax on gift card purchases?
If you discover you’ve been charging sales tax on gift card purchases when you shouldn’t have, you should immediately correct your systems and processes going forward. For past errors, you have several options depending on the scale and duration of the mistake.
First, review your sales tax filing history to determine how much excess tax you collected and remitted to states. You may be able to file amended returns to recover these amounts. However, you’ll also need to consider your obligation to refund customers who were overcharged.
Some businesses choose to issue credits or refunds to customers who can provide proof of overcharged gift card purchases. Others, if the amounts are small and scattered over many transactions, may work with tax authorities to redirect the excess collections rather than attempting individual customer refunds.
How do promotional gift cards and bonus cards affect sales tax obligations?
Promotional gift cards, like those given free with purchase or as part of a loyalty program, create unique sales tax considerations. Generally, if a gift card is given away for free as a promotion with no purchase requirement, no sales tax applies at either distribution or redemption in most states.
However, when a promotional card is given as part of a purchase (such as “buy $50, get a $10 gift card free”), the treatment varies. Most states consider the promotional card value as a discount or incentive rather than a separate taxable sale. Sales tax applies only to the items actually purchased, not to the promotional card value.
At redemption, sales tax typically applies to the full value of items purchased with promotional gift cards, just as with regular gift cards. The key distinction is that no tax was collected when the promotional card was issued since it was a marketing incentive rather than a paid purchase.
Discovered compliance errors in your gift card tax treatment? HOST’s voluntary disclosure services can help you resolve past issues while minimizing penalties and protecting customer relationships.
