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Wednesday, March 21, 2012

Mileage awards by banks, 1099s, and the realization principle

The excitement about Citibank issuing 1099s to customers who received a prize from the bank that was worth $600 or more has seemed to become yesterday news. But I wanted to expand upon an earlier post on the topic (1/26/12). A Forbes article by Kelly Phillips Erb of 3/1/12 noted that Citibank seemed to have valued the mileage at 2.5 cents per mile which is below what individual might have to pay (2.95 cents per mile). It also noted that some people have filed a lawsuit against Citibank saying they should have told them the award was taxable and they inflated the value.

So, what is wrong with our income tax system that people don't think that when they receive something from a business for doing something, it is not income? Well, people probably don't think the miles or points are really worth much because if they don't get enough points or use them in time, they are not worth anything. A poll by found that 2/3 of credit cardholders would "stop using their cards if the miles, points and cash back rebates they earn when making purchases were taxed as income" (2/28/12).

But what might those recipients think when they actually use the points such as to get a $300 airline ticket for free? Perhaps they would then consider it income (maybe). Miles or points are different from cash or a toaster or an iPad received as a prize because you might not ever use the miles or points and they might not be salable.

Would it make sense to have a rule that certain items received for doing something (that is, the item is not a gift) are not taxable until used?  The issuer could be required to have a valuation chart posted on its website and perhaps even filed with the IRS.

The income tax has a realization principle. This generally means that there is no income tax effect, such as for property owned, until it is disposed of. That is, you don't need to value your property at year end to see if it appreciated in value and include it as income. In Lakewood Associates v. Commissioner,  109 TC 450 (1997), aff’d 173 F3d 851 (4th Cir. 1998), where a taxpayer tried to claim a tax loss when property held for business use declined in value, the court said:

"The mere diminution in value of property does not create a deductible loss. An economic loss in value of property must be determined by the permanent closing of a transaction with respect to the property. A decrease in value must be accompanied by some affirmative step that fixes the amount of the loss, such as an abandonment, sale, or exchange"

The bank awards are not similar because the customer does receive something. But customers don't view it as having value until they use it or sell it.

Not taxing the point and mileage awards until used does add some complexity in valuing the items, but not impossible. Taxpayers would like view it as more fair because since the mileage award is a personal asset, if they don't use it, they can't take a deduction for the lost value.  This isn't perfect from a "balance" perspective on the income tax because the bank claims a deduction for buying the miles, but someone may never pick up the income. One solution would be to require banks to only deduct the cost of buying the miles from the airlines if eventually used by a customer. Extra recordkeeping though and it may lead the banks to stop the program. Which might be the best solution. They could use the savings to reduce bank charges.

What do you think?


J Drysdale said...

This has issues of "Simplicity" written all over it!! If credit card awards were to be taxable to the recipient there would be quite a few problems due to the complexity of this issue.

First of all many taxpayers will view this as unfair. Why should they be taxed on a perk of doing business with a company? This could be considered a fringe benefit of using the particular credit card. Not all fringe benefits are taxable. Taxpayers who choose to comply and report this as taxable income on their returns may make errors by accidently paying too much or too little tax on the awards.

If these credit card awards will be taxed this will lead to increased administrative costs and costs of compliance. The credit card issuers would have to rethink the costs/benefits of the awards programs to see if they are worth the increased costs to the company.

My thought is leave it alone...let the recipients enjoy their free flight once every few years(if there is even an eligible seat available on the airplane!) said...

Hi, nice post. I have been wondering about this topic, so thanks for sharing. I will certainly be subscribing to your