Hyatt Loses Tax Court Ruling With Huge Implications For Loyalty Programs, IRS Sought To Tax $250 Million

The IRS audited Hyatt for the tax years 2009 – 2011 and found that it wasn’t paying tax on loyalty program revenue. It didn’t include the revenue received for what was then Gold Passport (now World of Hyatt) in income, and didn’t include payments from the program as expenses. It just ignored the program, even though it collected money and invested it earning a return.

The IRS wanted Hyatt to not only pay up for those years but to go all the way back to the beginning of the program in 1987, with a quarter of a billion dollars of income at issue and a tax deficiency of $65 million. (This period is prior to the introduction of a co-brand credit card, and Hyatt has had few partners buying points, so the money at issue is largely from accrued points balances on hotel stays that hadn’t yet been redeemed.)

Hyatt argued that

  • it was merely a trustee of the fund on behalf of owners
  • it should be able to offset revenue with estimated future expenses against the fund

The litigation has the side effect of being interesting for sharing details of historical program economics, such as increasing the cost of the program for full service hotels in 2012 (with the cost to hotels for program member stays going from 4% to 4.5%) and the amount of compensation hotels received for redemption stays falling in 2011. It also discusses the program’s 2011 devaluation but I assume this must actually refer to June 2010’s introduction of category 6 redemptions.

PricewaterhouseCoopers estimated redemption costs and breakage (points that would never be redeemed, even before poitns in the program expired) and Deloitte audited the rewards fund for the years at issue.

2009 2010 2011
Program Payments $63,168,430 $77,195,168 $103,383,532
Marketable Securities — Net Gain 7,214,521 7,510,716 7,208,255
Interest Income 12,026,344 10,516,012 8,281,521
Total Income $82,409,295 $95,221,896 $118,873,308

Expenses were as follows:

  [*13] 2009 20010 2011
Advertising $21,165,826 $16,251,855 $10,620,650
Membership Acquisition & Enrollment/Fulfillment 3,679,263 4,749,127 13,607,160
Membership Communication & Marketing 7,121,477
Membership Statements & Processing 1,673,285 1,137,967
Call Center 6,806,864
General & Administrative 17,763,862 18,555,852 8,195,723

Future redemption estimates represented 46% to 61% of expenses, and Hyatt showed a loss each year as a result.

The fund is described as being owned by Hyatt-branded hotels, rather than by Hyatt, even though if a hotel left the chain it wouldn’t take any ownership stake with them – or even have access to the data that their expenses paid to maintain.

Hotels would pay into the fund when members stayed on property, and deduct those payments as an expense, even though they purportedly owned the bank accounts into which those funds were sent.

On Hyatt’s Form 1120, U.S. Corporation Income Tax Return, they reported the fund on Schedule L but didn’t include it in income or deductions. Its Schedule M3 allocated the fund reserves out to each domestic hotel and told hotel owners to consult their tax advisors on how to handle.

Hyatt claimed it did not directly benefit from the fund. The Tax Court ruled that Hyatt wasn’t merely a trustee of a fund that was beneficially owned by affiliated hotels.

To the extent that other chains are using similar accounting methods, one argument they may hang their hat on in continuing to do so is that Hyatt owns a disproportionately large share of its hotels and therefore directly benefited at the hotel level from advertising costs incurred by the fund. Hotels, for Hyatt, aren’t entirely a separate and arms-length entity. However that’s just one reason why Hyatt lost here. Indeed, the value of the program directly benefited Hyatt in other ways as well (though maybe this is not true for all hotel chains!):

Not only did customer goodwill generate repeat hotel stays and thus direct and indirect revenue for petitioner (as discussed above), but it also granted petitioner additional contractual leverage in its role as prospective franchisor or manager for hotel properties. Put another way, petitioner could rely on the increased goodwill associated with the Hyatt brand in negotiating higher royalties, management fees, and other fees in new agreements reached with existing or prospective TPHOs — a direct benefit to it.

The IRS argued that tax treatment of the rewards fund constituted a change in accounting treatment that allowed it to go back and assess taxes without respect to the statute of limitations for doing so. The IRS “lost on the retroactive inclusion of income.”

This decision has broad implications for rewards programs who aren’t recognizing income or losses on an annual basis for their rewards programs.

(HT: @aussieflya)

About Gary Leff

Gary Leff is one of the foremost experts in the field of miles, points, and frequent business travel - a topic he has covered since 2002. Co-founder of frequent flyer community, emcee of the Freddie Awards, and named one of the "World's Top Travel Experts" by Conde' Nast Traveler (2010-Present) Gary has been a guest on most major news media, profiled in several top print publications, and published broadly on the topic of consumer loyalty. More About Gary »

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  1. On the face of what you present it seems like a very simple case of tax fraud/evasion. Can’t claim loses and ignore taxable income.

    So unless every loyalty program is ignoring income and claiming
    losses it has littl Impact on loyalty programs – if it is widespread and yeah the chickems are likely to come home to roost

  2. Isn’t tax evasion why Al Capone ended up in Alcatraz federal prison? Tax cheats got caught, eventually

  3. I get slammed by the IRS for a miscalculation of under 500 and Hyatt went on for years defrauding the USGovt and people for 10s of millions. Sounds about right.

  4. So what are the implications that are explicitly referenced? I’m more concerned about the end of the line of dominos when the last one lands on us, the members of these rewards programs.

  5. At the hotel level, the accounting for rewards fees and redemptions has always been questionable. The multiple hotels I’ve worked for all did it differently, some applying redemption earnings toward the fees on the next franchise bill, like a credit…some outright just writing them off as an “allowance” in AR. Bottom line, in my experience, even the most seasoned GM doesn’t really have a good grasp on how this trickles down to the financial statement, and usually just does what the corporate office “tells them to” in order to make everything balance.

  6. Next step – start taxing points/rewards earned when travelling on OPM.

    You earn rewards for work – you pay tax on it.

    IRS just needs to find the technology to implement.

  7. @Ann There’s a reason the IRS chooses not to tax non-cash earnings. If they tax frequent flyer points, they have to tax health, life and disability insurance payments. No one wants that, not the government, not the insurance companies, not the employers.

  8. Health insurance is non taxable if it is a qualified plan (all employees treated evenly).

    As for travel awards, the US government is scrambling for revenue. If taxed, beneficiaries would receive 1099-MISC statements from credit card, airlines, hotels, etc. The issue the IRS had with Hyatt could be a front door in taxing hospitality and travel industry awards.

    Think about it, this credit card redemption frenzy is getting out of hand with folks applying for multiple credit cards solely for gaining points.

  9. Looks like the globalist breakfast is about to become a 1 dollar a day daily credit
    good for anything you want off the menu 😉
    As far as their premium hotels go there is no where else to go now that they are just as expensive or more expensive as most Marriott’s and Hilton’s when redeeming points.

    Most of the other programs use 10 points per dollar ratio.
    So just double the number of points when you redeem for Hyatt and then compare for yourself.

    The professional account in you understands this more than most.
    Hyatt’s glory days are somewhat over IMO with Park Hyatt’s being quite so stingy with upgrades.One might as role over and play dead at check in to get their attention after spending hundreds of nights to get recognition.Its not like they have near the massive volume of elites like Marriott

    Hyatt’s loss of MGM properties in LV another death knell to a fair degree and the Rio still so disgusting who in their right mind would go near the place?
    No wonder it isn’t participating in the program at present.
    Hyatt wouldn’t be able to keep up with all the complaints.See online reviews they are scathing
    I think Hooters & Circus Circus hotels scored better! Oh well have my popcorn out to watch what comes next lol.Is there a lawyer in the house here?

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