The Tax Implications of Customer Loyalty Cards

There’s a very interesting sales tax issue brewing here in Boulder, as reported in the local paper. Seems that someone in city hall has gotten the inspiration to tax a local coffee house, Vics, for the hundreds of free cups of coffee they hand out to frequent customers.
Vic's Coffee House, Boulder, logoLots of companies in Boulder have the customer loyalty device in question: a frequent buyer punch card or similar. I have about a dozen of them in my wallet or car glove compartment and they’re all generally the same: get ten punches and the eleventh is on the house. Whether it’s an expensive coffee drink, a burrito, a smoothie or even a sandwich, companies from Safeway to Wahoo’s Fish Tacos have these ubiquitous cards.
According to the paper, Vic’s owes the city approximately $3,000 in unpaid sales tax, which is being labeled “use tax”. Rather than just pay it or register a complaint through the chamber of commerce, Vic’s has brought its fight public by putting up a Web site and hosting a fund raiser for its legal fund. You can check out the site at Vic’s
I’m torn on this issue because on the one hand, I really like the loyalty card idea and it does help me decide to return to my favorite haunts on a regular basis, but tax revenue from commercial transactions are also an important source of funds for the city and the myriad of services I enjoy as a resident too.
Vic’s basic argument is that the sales tax for the paid portion of the loyalty transactions (e.g., the ten cups you have to buy to get the eleventh free) are sufficient and that the cost of the eleventh cup is already factored into the price of the ten paid cups, so the city’s already received the sales tax in advance for that freebie cup.
If you think about the economics of running a business, that must be true because however inexpensive the cost of a free burrito, sandwich or latte, it’s still non-zero and that money has to come from somewhere, but I have to admit that it makes me feel a tiny bit squeamish that the price of goods is artificially inflated to pay for freebies that I might not every enjoy if I’m not a regular patron of the establishment.
At some level I think it’s a pragmatic issue: both residents and visitors to Boulder clearly demonstrate the effectiveness of loyalty programs through their shopping and eating habits, and anything that keeps customers coming back to a local business must be good — in the long term — for Boulder’s tax coffers.
My conclusion: the city should be happy with the tax collected by the paid portion of the loyalty program and happy that local businesses have such an effective tool to help generate more business and revenue.
The alternative really can cripple smaller businesses in particular. No “10% discount for frequent customers”, no “buy three get one free”, none of that, not even down by CU, where these programs are omnipresent. The end result is to take away an effective retail business tool, and that could prove a greater cost to the city than any potential tax revenue from these loyalty programs.

7 comments on “The Tax Implications of Customer Loyalty Cards

  1. As far as I see it (as a computer guy, not a lawyer), either:
    1) It was prepaid by the previous 10, as you describe. So you pay a bit more for each previous one, and added up it pays for the “freebee”
    2) They are selling the free one at $0. Any percent sales tax on zero is zero.
    I’m not sure what the city’s claim is.

  2. Dave,
    I doubt Vic’s hired an MBA to analyze their cost structure and to bump their coffee prices 9% to allow for the 11th cup free with no impact on bottom line. I’ll bet their coffee price today is the same as before the loyalty card. I’ve always looked at it as a 9 or 10% discount… as long as I return often enough. Which is way the darn city should look at it. I’ve already paid for the cup and the sales tax ahead of time.
    In most coffee locations Boulder is already picking up $1.25 or more parking for that coffee in addition to the tax. To be fair, the city should be paying Vics and other establishments for attracting parking meter business.
    I had a 7:30a meeting at Saxy’s Coffee in Boulder a couple of weeks ago. I actually bragged how I felt like I was pulling one over on the city by meeting at 7:30 since the parking meters start at 9am. Unfortunately, my meeting went until 9:15 and I picked up a $15 parking ticket. The parking system is virtually perfect in Boulder.
    I think I just prepaid another 50 or so taxes on 50 free cups of coffee from Vics.

  3. I guess if they are going to tax that, they should probably be taxing every free sample that any business ever supplies anyone. It’s the same argument – someone did actually ‘use’ it.

  4. Dave,
    As others have mentioned it was prepaid by the previous purchases.
    The real issue is that its easier to look at methods to increase tax revenues to cover municipal costs/expenses, rather than deal with the inefficient and poorly controlled spending of current taxes.

  5. Sounds like the city of Boulder is getting pretty desperate. If they look hard enough they could probably invent many other reasons they should be taxing more.
    I hope they don’t have much chance in getting this past.

  6. How much is Boulder getting from the airlines for all those frequent flier miles? Surely, there is some argument those city yahoos can think up to tap into those revenues as well.

  7. Wow! The city of Boulder is bold. They obviously don’t concern themselves with national tax precedents on the subject of loyalty reward taxation.
    I’ve worked in loyalty program development and analysis for over 20 years and some of this time was spent calculating program liability and the national effect of federal taxation of loyalty programs–mind you my analysis was against taxation, not for it.
    The problem is simple: You can’t tax one loyalty program and not tax another, and even if loyalty programs were taxed universally, how do you define loyalty programs from sales promotions? Is a “buy-one-get-one-free” sale a loyalty program that should be taxed? Secondly, how do you “police” the use of rewards when many loyalty programs don’t track reward usage (e.g., punch cards thrown away)? The issue becomes one of customers self-reporting rewards–yeh, right! And how does the city know the value of the reward to be taxed? Maybe the customer bought ten $4.00 cups of coffee, but the free cup cost only $2.50. These are just three issues. There are numerous problems in trying to establish a taxation policy that is fair or is accountable. It’s amazing to me that the city of Boulder thinks they can tackle an issue that the federal government hasn’t mastered in the 20+ years I’ve been working in loyalty marketing strategy.
    If Vic’s Espresso wants to give me a call (see my contact info at, I’d be happy to help their legal team in exchange for a cup of coffee–on second thought, Vic’s might be taxed on the cup, so I’ll just help them for free. Is the city going to tax Vic’s for my pro bono help too?
    Vic: Save your money. This case shouldn’t even go to court if the city can be enlightened on the fatal flaws in their proposal.
    Ellen Reid Smith

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