Should I tax customers for gift cards?

Right now, people are in deep gift-giving mode, and gift cards are flying off the racks. If you sell gift cards, it can be great for your end-of-year profits. After all, you get paid upfront, and if the gift cards are for your business, you bring in customers who often spend more money than the amount gifted to them. More money for you.

That said, if you are charging customers who purchase gift cards a sales tax, stop now. Doing so is against the rules. Here’s why:

When customers buy gift cards, they are exchanging cash for a card of equivalent value. At the time, neither you nor the purchaser knows where and how the recipient will use the card. For example, the recipient could use a $100 card for 50 $2 purchases or put it toward one $200 purchase. The recipient could use the card in California or Maine, at your location or at one in a jurisdiction that charges a higher local sales tax. So you have no way of knowing how much sales tax to actually charge to apply to what the card might actually end up paying for.

More important, however, is that recipients of gift cards are going to be charged sales tax when they use their card -- if the state they’re shopping in imposes a tax on the product they’ve purchased. For example, if you send your cousin in Pennsylvania a Banana Republic gift card, she won’t need to pay sales tax on clothing when she uses it. Your cousin in Virginia will.

Bottom line: If you charge buyers sales tax when they purchase a gift card, that purchase is being taxed twice. That’s clearly against the rules.

Make sure that your point-of-sale system isn’t automatically applying a sales tax to gift card purchases, educate your employees about what is and isn’t taxable, and be prepared to issue refunds if you accidentally do collect a sales tax on a gift card purchase.