One of the most common perks of using an airline, using a credit card, or opening a new bank account is the ability to earn frequent flyer miles or more flexible reward points. These miles and points are not cash, but they can be exchanged for a variety of goods, services, or benefits. As a result, these miles and points clearly have value. However, many taxpayers aren’t sure whether this value is considered taxable by the IRS, and in turn, whether that value needs to be reported on their tax returns.
There is not a single answer to this question. This is because, in general, there are two distinct methods that these miles and points can be earned. The first is by purchasing goods and services, typically from an airline or travel provider or by using a credit card. The second is by opening a bank account and then making a deposit and/or maintaining a balance. The IRS treats these two methods, as well as the miles and points earned through them, in very different ways.
When miles or points are earned through travel provider or credit card purchases, the IRS considers them nontaxable rebates. In other words, the miles or points are treated as a reduction in the price paid for the goods or services in question. As a result, they do not need to be reported as income on an income tax return. This treatment applies whether the card and/or purchases are used for personal or business purposes.
In fact, the IRS’s Announcement 2002-18 notes that “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.” This not only makes clear that the IRS will not consider the receipt of miles or points to be taxable, but also that the IRS will not consider the personal use of miles or points earned through business travel or expenses to be taxable. It’s important to note that Announcement 2002-18 left the option open for the IRS to change its stance in the future. However, it has yet to do so.
However, this treatment also means that if these points or miles are used for a business expense, the value of that expense is not separately deductible. For example, if you use 50,000 credit card points to buy a plane ticket worth $500, you cannot deduct $500 as a business travel expense, because you did not actually pay $500.
Also, please note that, per Announcement 2002-18, this nontaxable treatment does not apply if the miles or points are converted to cash. For example, if an employer pays his employees to use their personal miles to pay for business travel expenses, the payments are taxable to the employees.
On the other hand, when miles or points are earned through a bank deposit, the IRS considers their value to be taxable income. This IRS stance was most recently affirmed by the Tax Court in the 2014 case Shankar vs. Commissioner. This case concerned Parimal Shankar, who received 50,000 points from Citibank as a reward for opening a bank account. Shankar then used these 50,000 points to buy an airline ticket, and Citibank then valued these 50,000 points at $668 and reported payment of that amount to Shankar. However, Shankar did not report this amount as income on his tax return, and the IRS in turn claimed that his income was underreported.
The Tax Court agreed with the IRS, and went on to rule that: “We proceed on the assumption that we are dealing here with a premium for making a deposit into, or maintaining a balance in, a bank account. In other words, something given in exchange for the use (deposit) of Mr. Shankar's money; i.e., something in the nature of interest. In general, the receipt of interest constitutes the receipt of an item of gross income.” In other words, since Shankar earned the points in connection with allowing Citibank use of his money, the compensation he received for that was treated as any other compensation for allowing a bank use of money would be – as interest income.
As a final note, keep in mind that this area is always in flux, and as a result the IRS’s stances may change as well. As businesses look to attract more customers, the value of noncash rewards has increased significantly over the past several years. If they continue to do so, it will become more and more likely that the IRS will direct further effort into taxing the value of these rewards.
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