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Revenue from Hotel's Operating Fund Was Not Excludable Under Trust Fund Doctrine

(Parker Tax Publishing October 2023)

The Tax Court held that the parent company of a hotel chain that established an operating fund to compensate third-party hotel owners when customers redeemed points under a customer rewards program to include in its taxable income the revenue it received from investments of the fund's assets. The court found that the taxpayer was not entitled to exclude the income under the trust fund doctrine, recognized by the court in Seven-Up Co. v. Comm'r, 14 T.C. 965 (1950), because the taxpayer directly benefited from the fund and how it exercised its control over the fund. Hyatt Hotels Corp. & Subs. v. Comm'r, T.C. Memo. 2023-122.


Since 1987, Hyatt Hotels Corp. and Subsidiaries (Hyatt) has operated a customer rewards program, known as the Gold Passport Program (Program). Participating travelers who stayed at Hyatt-branded hotels received rewards points, which when amassed in a sufficient number could be redeemed for a free stay at any Hyatt-branded hotel.

Hyatt owned roughly 25 percent of all Hyatt-branded hotels; the rest were owned by a variety of third party hotel owners (TPHOs), who contracted with Hyatt for use of its hotel management services and/or its brand name and other intellectual property. When a participating traveler received rewards points for a stay at a Hyatt-branded hotel, Hyatt required the TPHO to make a payment into an operating fund, which was held by a Hyatt subsidiary and known as the Gold Passport Fund (Fund). When a participating traveler redeemed rewards points for a stay at a Hyatt-branded hotel, Hyatt would make a compensation payment to the hotel owner out of the Fund. Portions of the Fund's unused balance were invested in marketable securities and resulted in realized gains and accrued interest. Hyatt also used the Fund to pay administrative and advertising expenses that it determined were related to the Program.

For federal income tax purposes, Hyatt essentially ignored the Fund, including none of its revenue in gross income and claiming no deductions for expenses paid. The IRS determined that this tax treatment was improper. The IRS further determined that Hyatt's treatment was a method of accounting and that Hyatt thus had include in income as a transitional adjustment its net revenue from the Program since 1987. The IRS issued a notice of deficiency memorializing those determinations, and Hyatt filed a petition with the Tax Court.

Hyatt maintained that its treatment of the Fund was proper under the trust fund doctrine, arguing that it held the Fund as a trustee, agent, or conduit for the hotel owners and not as the true owner for tax purposes. In the alternative, Hyatt contended that the IRS overreached by characterizing its treatment as a method of accounting and thus the transitional adjustment should not be sustained. Also in the alternative, Hyatt contended that it should be able to offset its gross receipts with the estimated cost of future compensation payments to hotel owners by way of a longstanding regulatory provision known as the trading stamp method.

Trust Fund Doctrine

In Seven-Up Co. v. Comm'r, 14 T.C. 965 (1950), the Tax Court recognized an exclusion from gross income known as the trust fund doctrine. There, the taxpayer created and maintained a collective fund for the purpose of paying for national advertising of its signature soft drink beverage. Some third-party bottlers of 7-Up, who regularly purchased extract from the taxpayer, voluntarily contributed into the fund, which was then used to pay for national radio and magazine advertising. The issue was whether the payments into the fund were includible in the taxpayer's gross income. The Tax Court characterized the payments made by the bottlers as neither "for services rendered or to be rendered" by the taxpayer nor "part of the purchase price of the extract." The court concluded that the payments were not includible in gross income, reasoning that the taxpayer did not gain or profit because of the fully offsetting restriction on its use of the fund.

Since Seven-Up Co., the Tax Court has refined the applicable legal test, which now holds that when a taxpayer (1) receives funds in trust, subject to a legally enforceable restriction that they be spent in their entirety for a specific purpose and (2) does not profit, gain, or benefit from spending the funds for that purpose, then the taxpayer may exclude such funds from gross income. When both elements of the trust fund doctrine are present, the taxpayer is deemed to be a mere conduit or custodian of funds and not the beneficial owner for federal income tax purposes. Under the trust fund doctrine, any benefit inuring to the taxpayer from use of a purported trust fund cannot be more than incidental and secondary. For instance, if a taxpayer's use of the purported trust fund directly increases the value of its property, the trust fund doctrine is typically inapplicable.

Hyatt contended that it was legally restricted in its use of the Fund by (1) the applicable management and franchise agreements with the TPHOs, (2) a course of dealing between it and the TPHOs, and (3) fiduciary duties arising by way of an agency relationship between it and the TPHOs. Hyatt further contended that it did not directly benefit from its use of Fund. The IRS asserted in turn that Hyatt's use of the Fund was not so restricted and that Hyatt directly benefited from the Fund.

Trading Stamp Method

The general rule for accrual method taxpayers is that a liability is incurred and thus taken into account for federal income tax purposes once it has satisfied the all events test. Under the all events test in Reg. Sec. 1.461-1(a)(2)(i), a liability is incurred for the tax year when (1) all the events have occurred that establish the fact of the liability; (2) the amount of the liability can be determined with reasonable accuracy; and (3) economic performance has occurred with respect to the liability.

A narrow exception to the all events test is provided in Reg. Sec. 1.451-4(a)(1) for an accrual method taxpayer that (1) issues trading stamps or premium coupons with sales and (2) such stamps or coupons are redeemable by such taxpayer in merchandise, cash, or other property. If both conditions are applicable, the taxpayer may offset against gross receipts from such sales an amount equal to the cost to the taxpayer of merchandise, cash, and other property used for redemptions in the tax year plus the "net addition to the provision for future redemptions" during the tax year. The trading stamp method effectively accelerates what otherwise would have been future year deductions and serves as an exception to the general rule that reserves for contingent liabilities are not deductible.

As applied to this case, the trading stamp method would allow Hyatt to offset against gross receipts both (1) the cost of current year redemptions (i.e., current year compensation payments) and (2) the net addition to the estimated cost of future tax year redemptions that corresponds to rewards points issued to members during the tax year. The parties' primary disagreement regarding on this issue was whether the rewards points were redeemable in "merchandise, cash, or other property." The IRS argued that the rewards points at issue were redeemable for services (i.e., hotel stays and air travel), rather than "merchandise, cash, or other property." Hyatt contended that the rewards points were redeemable instead for the right to receive a hotel stay or airline miles, which qualified as "other property."


The Tax Court held that the trust fund doctrine did not apply and that Hyatt had to include the Program revenue in gross income. In the court's view, Hyatt's beneficial interest in the Fund could be inferred from the significant control that Hyatt exercised over the Fund. The court found that Hyatt mandated that the TPHOs participate in the Program and pay into the Fund, controlled the amounts of Program payments in and compensation payments out of the Fund, decided how to invest the Fund, accrued interest and realized investment gains from holding the Fund, and determined whether particular advertising or administrative costs would be paid for by the Fund - all without oversight or input from the TPHOs. The court observed that aside from the generalized Fund financial statements, the TPHOs had no access to the details of what specific expenses were being paid out of the Fund. Accordingly, the court found that Hyatt essentially retained the right reimburse itself out of the Fund at its own discretion.

In turn, the court found that Hyatt benefited in a number of ways from its control over the Program and Fund. The court noted that since Hyatt owned 20-25 percent of Hyatt-branded hotels and was the largest single owner of such hotels, having Program advertising paid for out of the Fund effectively shifted to the Fund the cost of at least some of the advertising that Hyatt otherwise would have paid for. The court also found that, as the owner of Hyatt trademarks, Hyatt benefited from Program advertising which included such trademarks and thus maintained and enhanced the value of Hyatt's goodwill. In the court's view, customer goodwill not only generated repeat hotel stays, it also gave Hyatt additional contractual leverage in its role as prospective franchisor or manager for hotel properties.

The court concluded that, given the totality of Hyatt's control and discretion over the Program and the Fund and how its use of the Fund directly benefited it, Hyatt failed to establish that the trust fund doctrine applied. In the court's view, Hyatt was more than just a mere intermediary or conduit, passively holding funds and then remitting them on or for the convenience of others, with only an incidental benefit to itself. Instead, the court found that Hyatt had a sufficient beneficial economic interest in the Fund to be liable for tax.

However the, Tax Court rejected found that Hyatt's prior treatment of the Program revenue was not a material item and therefore not a method of accounting. The court reasoned that Hyatt's consistent, total exclusion of the Program revenue and non-taking of deductions for Program expenses did not involve timing, at least so long as the Program continued in perpetuity. The court also found that if the Program were terminated, any remaining balance of the Fund would have been refunded to the participating hotel owners, and thus Hyatt still would not have reported the Fund in gross income or taken deductions. Therefore, the court did not sustain the IRS's determination of a Code Sec. 481 adjustment.

In addition, the Tax Court found that the trading stamp method was not available to Hyatt for the years at issue; instead, Hyatt had to defer its cost recovery until the tax year for which compensation payments gave rise to a deductible expense. In the court's view, whether Hyatt's hotel guests were considered to possess a license or a leasehold interest, the text of Reg. Sec. 1.451-4(a)(1) did not support a reading that such an interest would qualify as "other property" within the meaning of the regulation. The court reasoned that understanding "other property" to broadly encompass all manner of property rights would render the carefully delineated "merchandise" and "cash" categories as surplusage. To give separate effect to all three categories, the court found that the scope of "other property" must be limited to property similar in nature to merchandise and cash.

For a discussion of exclusions from income, see Parker Tax ¶75,101. For a discussion of changes in method of accounting, see Parker Tax ¶241,590. For a discussion of the trading stamp method, see Parker Tax ¶241,730.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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