Gift cards and sales tax: How not to get duped

Gift card purchases are supposed to be tax-free, but some retailers are breaking state rules or finding loopholes so that gift cards are taxed twice. Here's how to keep your gift card purchases tax-free, the way they should be. 

Gift cards are a versatile gift for the recipient — and a convenient and easy purchase for the giver. They can even make a smart purchase for yourself, as with iTunes gift cards, which are almost always on sale.

Part of that convenience of gift cards is that they are tax free when purchased. But some retailers are breaking state and even their own rules on the matter, or finding loopholes, as we learned from some of our readers. If you're not careful, you could end up getting taxed twice.

While these rules are not federally mandated or explicitly spelled out in every state, we outline the best evidence we could find on tax-free gift cards, and tell you how to handle retailers that ignore them.

Why Gift Cards Aren't Taxed At Purchase

According to Tim Gagnon, Assistant Academic Specialist of Accounting at the D'Amore McKim School of Business at Northeastern University, "most states sales tax does not apply to the purchase of a gift card. The transaction is viewed as exchange of cash for cash equivalent with no additional value or service rendered."

There is no centralized list of every state's gift card sales tax policies- probably because most don't explicitly have any- but the experts agree. "To my knowledge, no states charge sales tax on gift cards," says Shelly Hunter, a.k.a. "The Gift Card Girlfriend" at GiftCards.com.

Taxing gift cards also just wouldn't make sense: though the card is bought in one state, it could be redeemed in another with a completely different sales tax. Also, it could create a potential double-whammy if both the gift card itself and the purchases made with it are taxed.

One New York state lawmaker tried to change this by taxing gift cards, but making purchases made with the card tax-exempt. However, this would likely be a huge headache for retailers. It would require a POS system that recognizes out-of-state gift cards, which won't be coming any time soon.

But It Still Happens

Many of the major players, like Amazon and Target, clearly state: "No sales tax is charged when purchasing gift cards; however, purchases paid for with gift cards may be subject to tax."

Unfortunately, some retailers don't seem to have gotten the message. GameStop is a repeat offender, perhaps because it doesn't consider prepaid Xbox cards to be the same as gift cards (they are). GameStop was caught taxing cards in Illinois in 2008; and they were still going at it in 2013.

What To Do

Unfortunately, there's really only one thing you can do if you incorrectly get taxed while purchasing a gift card: "Shoppers who have been charged sales tax when buying gift cards or gift certificates should return to the store with their receipt and ask for a refund," said Connecticut Revenue Services Commissioner Kevin B. Sullivan in 2013. If it's a small retailer, it's likely just an honest mistake, and the owner will be happy to recoup the tax when the credit is redeemed at the same location.

Have retailers charged you sales tax when purchasing gift cards? Which ones, and how did you handle it? Please let is know in the comments section below.

Benjamin Glaser is a features editor for Dealnews.com, where this article first appeared: http://dealnews.com/features/Sales-Tax-and-Gift-Cards-Have-You-Been-Duped-/1125475.html