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Thursday, January 26, 2012

Bank and credit card rewards - taxable?

An article in the Los Angeles Times today (1/25/12) -"Citibank deems frequent-flier miles taxable, but does the IRS?" by David Lazarus covers a story that raises question about what does the "income" in "income tax" mean. Citibank issued Forms 1099-MISC to customers who received frequent flyer miles from Citibank for opening accounts, if the points were valued at $600 or more. This caught the customers by surprise.

Are the miles taxable? Good question.  And do note that the answer has little to do with their value.  Even customers who received points worth less than $600 have income if this is indeed income. Just because you don't get a 1099 doesn't mean you don't have income.  It is just that $600 is the threshold for reporting such income to the IRS. But, if the bank gives you a cheap pen or a cup of coffee, it's not taxable to you.

Here is what the US Supreme Court said in 1955 in holding that punitive damages were income to the recipient - "undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion" is income (Commissioner v Glenshaw Glass, 348 US 426).

Could the points be considered a gift?  I don't think so. In 1960, the US Supreme Court said that a "gift in the statutory sense ... proceeds from a "detached and disinterested generosity," ... "out of affection, respect, admiration, charity or like impulses." .... And in this regard, the most critical consideration, as the Court was agreed in the leading case here, is the transferor's "intention."(Commissioner v Duberstein, 363 US 278).

It doesn't seem to be a gift because Citibank wanted something in return for the points - your money!

The Citibank situation is not like two slightly similar situations that do not generate taxable income:
  1. You buy a new car and the dealer gives you a $500 rebate.  The $500 is not income to you. The substance of this transaction is that the car really cost $500 less. This is a reduction in the purchase price. (This is also the view of the IRS - Rev. Rul. 76-96.)
  2. You use frequent flyer miles you earned by buying airline tickets. In Announcement 2002-18, the IRS stated, "the IRS will not assert that any taxpayer has understated his federal tax liability by reason of the receipt or personal use of frequent flyer miles or other in-kind promotional benefits attributable to the taxpayer's business or official travel. Any future guidance on the taxability of these benefits will be applied prospectively."  So, the IRS isn't saying the miles are not income, just that there are difficulties in making the determinations. But in some cases though it may be possible to reach a more definitive answer. For example, you only purchase airline tickets for business use. When you cash in your miles, you obtain more travel used for business purposes. This is really like the car rebate example - no income. The challenge is that many people earn miles for both business and personal travel and likely redeem them for personal travel which means they should pick up income or reduce the business deduction for the miles - but how do you value them.   The IRS also notes in the 2002 announcement that, "This relief does not apply to travel or other promotional benefits that are converted to cash, to compensation that is paid in the form of travel or other promotional benefits, or in other circumstances where these benefits are used for tax avoidance purposes"
 So far as benefits received from banks and credit card companies, the tax effect seems to depend on the details of the arrangements. Many of these arrangements do not seem to be like the car rebate situation because the company awarding the points has not sold you anything - they really seem to be rewarding you to use the credit card. But what about a credit card issued by Store X that rewards you with Store X gift cards if you purchase a certain amount of goods from Store X?  That sounds like the car rebate.  But what if it is Store X issued VISA card that you can use anywhere and all of your purchases help earn you rewards?

Perhaps the IRS will step in and say something again in light of this Citibank action.  Perhaps customers will ask more questions before taking the points.

How can this be made more simple? Here are two possibilities.  (1) Require the giver of the award to issue the 1099 at the time the person is about to take the action so they can stop the action if they don't want to income.  Also, while you are generally not allowed to turn your back to income you should be allowed to in the case of awards and rewards.  (2) Enact a de minimis threshold for rewards that are excludable from income, such as $50.

What do you think?

6 comments:

Steven J. Fromm & Associates said...

Well it is taxable income. It reminds me of home run baseballs of famous players being worth money as soon as received. Income there too. But a de minimus rule may come from the IRS? Probably not. One point, Citibank really is out there doing the best for their customers by nailing them with Form 1099s on a questionable item. Once again are banks are really there to serve and protect their clients! Good job guys, send Form 1099s to all your best customers; that should engender a lot of goodwill!

Angelina Smith said...

Law students should read this blog post. My professor definitely liked to ask questions like this. Thanks for the info!

Professor Nellen said...

On 1/30/12, the Los Angeles Times had a follow up story with a statement from an IRS representative:

""When frequent-flier miles are provided as a premium for opening a financial account, it can be a taxable situation subject to reporting under current law," said Michelle Eldridge, an IRS spokeswoman."

She apparently compared the "premium" situation to one where the item received is more like a rebate on something you purchased.

Here is the link to the LA Times story - http://www.latimes.com/business/la-fi-lazarus-20120131,0,1163342.column

Arguably, if the Citibank customer is charged an account fee, the "award" from Citibank can be viewed as a return of part of that fee. If it is a personal account, nothing was deductible by the customer for paying the fees so there is no tax significance. If it was a business paying the account fees and the person who gets the award uses it personally, there is a tax significance in that the business deduction for the account fees should be reduced by the award used personally. If used by an employee (rather than self-employed person), the award is income to the person who used it.

I think it is sometimes difficult to know why credit card companies are giving awards. Are they somehow filtered through the credit card company by the stores where the cards are used - more like a non-taxable rebate? or something else?

And don't forget that even if you didn't get a 1099 because your prize was under $600, if income, it is still taxable!

Relationship Banking said...

Bank awards are usually taxable, credit card rewards are usually not. I believe credit card rewards are viewed as "rebates" while bank rewards are viewed as "dividends" and hence the difference. Is there an option to void it?

Rich Golze said...

What defines de minimus. If a home builder buys 200,000 worth of supplies at home depot on his credit card and gets free trip to hawaii for his family, wouldn't that be taxable?

Professor Nellen said...

On the home builder example - I say yes, taxable. The business got a discount for the quantity of purchase and it was used for personal purposes.