Had a couple of discussions lately about “points-based programs” and thought some of the conversation might make for interesting reading. No particular point to this post other than to share some info and hopefully get some commentary.
Incentive Companies Sell Points
As you know (or may not know) but points-based programs have been the staple of most incentive companies for going on 80 years or so. They were the incentive version of the old “stamp” program. Each “behavior” or result is worth “X” points. Do the stuff and get the points. In the old days participants would actually get “point checks” in the mail which they would send in with their award order. Nowadays it’s all electronic. Just like a cash checking account – participants have a balance and order online and their point account is deducted by the amount redeemed. Piece of pie… easy as cake.
Billing on Redemption or Billing on Issuance?
For years the incentive industry sold “points” – they were worth roughly ½ cent. So 200 points = $1.00 (you’d be surprised how many newbies just couldn't do that math.) As points were redeemed, they were billed to the client. So, if you were the client and in November 100,000 points were redeemed, you got a bill for $500 (200X$500 = 100,000.)
All was good. You only paid if someone redeemed. You could issue all the points you wanted. You only paid for those that were converted to awards.
That makes a lot of sense to me. You pay for the awards right?
There are other incentive companies that sell from a position of “pay for performance” meaning they bill the client for points earned by the participants - not redeemed. In this scenario points become the proxy for performance. The point being if someone earned the points – the client got the performance (which is what they wanted right?) and the incentive company can collect for those points issued. This actually makes a ton of sense to me too.
So it makes sense to bill for redemption and it makes sense to bill for issuance. Your call on that one. I can see both sides of the argument.
Breakage – Shrinkage (not the Seinfeld kind)
What happens to points issued but not redeemed?
That, in incentive industry parlance is, “breakage” (or some may say shrinkage.)
If you bill on issuance then you receive money when the points are earned and have that money in-house sometimes for 12 months before someone redeems for an item. That’s a long time to have someone else’s money in the bank earning interest.
If you bill on redemption – you don’t realize any income (‘cept for services) until someone redeems.
Now fast-forward 12 months
A bill-on-issuance company may only see 80% of the points issued actually redeemed. That means 20% of the points billed for are 100% profit. Who’s money is that? Most clients would say it is theirs. But remember – they’re paying for performance not awards. Points are just a proxy for performance. Many incentive companies feel that is their reward for getting “lots ‘o performance.
Same 12 months into the future and a bill-on-redemption company sees only 50% of the points redeem. They’ve run a program for 12 months with an expectation of say $1,000,000 and they are only seeing $500,000 in points redeemed. Does the client pony up the extra $500,000? Not very likely. The incentive company takes the hit (which is one reason awards are a bit higher than traditional retail btw.)
Enter Mr. Taxman Just to Make It Interesting
Over the past 10 years or so the IRS has gotten a bit aggressive on point programs and has indicated that points earned in a program (whether redeemed or not) are considered income and need to be accounted for in either a 1099 or W2. Not a big deal – most incentive companies can handle that reporting very nicely.
Now the IRS rules can be “interpreted” and many companies do. They decide that the IRS really doesn’t mean “earned” they mean redeemed and therefore only report W2 and 1099 on redemption. I’m not a tax expert and I’m surely not one to argue with the IRS – some folks feel pretty strong and want to go toe-to-toe. You be the judge if there is wiggle room (link to IRS Pub 525.)
To Redeem or Not Redeem
Bill on issuance companies are pretty happy with non-redemption (increases the number of 100% profit points.)
Bill on redemption companies want everyone to redeem everything – that's the only way they get revenue.
But in both cases the participant will most probably be taxed on their award EARNINGS.
So… did the person earn an award at the time of issuance (as the IRS says and bill-on-issuance incentive companies)?
Or is the award earned at the point of redemption?
Did you get paid if you didn't cash your paycheck?
Same thing no?
Okay – discuss.

Man, you're making me think today with these posts! I'm more in the "at redemption" camp. Just like me to go against what the IRS thinks. But I digress. For example, someone gave me a gift certificate 18 months ago for a massage. I just found it, never used it, and now it's expired. Did I get a gift? Nope. But the spa got their $70. I'd rather that person have handed me the money or an actual thing. Incentives are like that. If I have points in a "bank" but forget to cash them in, I have not really been rewarded. IMHO.
Posted by: Trish McFarlane | December 09, 2010 at 12:56 PM
but if they came from a company for performance you've been taxed...
someone - no matter how you slice it ('cept the gov) gets the short end.
Posted by: Paul Hebert | December 09, 2010 at 02:13 PM
It seems we are fencing with windmills - the law is the law, and the IRS enforces the law. We may wish it otherwise and want to look at other events outside the employee-employer (or mfg-channel partner) relationship, however this "remuneration of value" is taxable, even if the recipient does not do anything with it (like cash or redeem it).
The good news (if there is any when it comes to taxes) is that the employee (if the award is "grossed up") has received a deposit into their withholding account with the taxing authorities.
Posted by: Rodger Stotz | December 10, 2010 at 04:21 PM
Agree - if the award is grossed up all is good. However, I'd argue that we aren't fencing at windmills - there are many, many clients that still pay on redemption and tax on redemption, don't include all incentive awards and play the game of chicken with the IRS. Right or wrong (my interpretation is they are wrong) they have received, hopefully, advice from their own legal counsel - which is what I always recommend.
The key question is how much do companies do to make sure any award points they have paid for and taxed on are redeemed? How much do the incentive companies push that with their clients? If you buy programs - ask that question.
Posted by: Paul Hebert | December 10, 2010 at 04:28 PM
Hi Roger and Paul. As we have been gathering insight from neuroscience and psychology advances, turns out accumulating points allows a build-up of anticipation that not only enhances the reward when points are redeemed, but also is in itself a reward. Psychology and neuroscience both demonstrate that an imagined reward triggers the same response in the brain as the actual reward (Knutson, et.al., 2007; Rauschecker, 2009). Seems to only bill on issuance is a bargain considering that the recipient get a) the points (earning/goal attainment is rewarding), the anticipation of an eventual reward (an additional reward) and finally the reward itself. BTW, a non-cash item or reward experience is better held in memory and cognitively associated with the company and behavior/activity for which it was received, effectively extending the value of the reward to the company. Perhaps we should bill on the earn instead?
Posted by: Michpoko | December 13, 2010 at 04:50 PM
Thanks Michpoko - appreciate the input. I've posted a couple of times on the impact of imagined vs. real awards - but haven't been able to convince a client to pay me on the illusion of awards yet (the holy grail me thinks.)
Thanks for summarizing all the value (and impact) the process of earning awards/rewards has on the brain. We forget that even the process itself is rewarding - but typically - we keep focusing on the tangible "thing" at the end. Maybe the appropriate billing process is to break it down into increments of billing based on the steps you outline. That would be very interesting indeed.
You've given me some stuff to think about. Appreciate it.
Posted by: Paul Hebert | December 13, 2010 at 05:49 PM
I enjoy your topics and conversations, Paul. I'm trying to carve time to read and share more on how our study and application of the latest in 'human sciences' really informs new ways to think about incentive design, and what and how to motivate and reward people. It makes it clear that we require a much more complex formula to influence human behavior than just do this, acquire that. PS - Rodger, sorry I misspelled your name... hope you are well, happy holidays ahead to you both!
Posted by: Michelle Pokorny | December 13, 2010 at 09:04 PM
I look forward to more of your contributions. Feel free to suggest some ideas and thoughts for posts. And happy holidays to you!
Posted by: Paul Hebert | December 14, 2010 at 06:32 AM