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Tax Treatment of Rebates May Be Clearing Up

How to manage these payments' tax recognition.

October 2008
by Larry Maples/Journal of Accountancy

Rebates are used in many vendor market channel programs to accomplish objectives such as jump-starting a market, overcoming market barriers and supporting a market until economies of scale can reduce production costs. The income tax treatment of rebates, however, has been a simmering dispute for more than 50 years, leaving uncertainty for both payers and recipients as to characterization and timing.

Recently, the IRS has taken steps to reduce some of the confusion. But a major issue remains unsettled: whether a rebate is a sales price adjustment reducing gross income (exclusion) or a deduction from gross income. This would be a distinction without a difference for federal taxable income, which is reduced either way, except that a deduction is subject to the restrictions of IRC § 162(c) (state sales taxes could also be affected). Thus, rebates that have not qualified as exclusions have been disallowed altogether when the IRS held them to be not ordinary and necessary, or when the payment fit one of the prohibited categories of section 162(c), such as illegal payments or kickbacks.

The rapidly evolving position of the IRS can be viewed through the prism of a series of pronouncements on Medicaid rebates paid by drug manufacturers. In FSA 200101004, the IRS advised that such rebates paid to state agencies were not sales price adjustments. Then in Revenue Ruling 2005-28 and, more recently, in Revenue Ruling 2008-26, the IRS reversed that position using the identical fact pattern. This reversal should not be narrowly interpreted to apply only to Medicaid rebates, because in these more recent rulings the IRS also announced it was suspending an earlier ruling (Revenue Ruling 76-96) that had held that rebates paid by automobile manufacturers were business expenses.

This has been excerpted from the Journal of Accountancy. Read the full article here.