As of 2016, credit cards have become the preferred payment method of most Americans.[1] As is expected when there is a large influx of demand, many credit card providers have joined the market to take advantage of this turning point in America’s monetary history. In order to keep up with the competition, credit card providers have offered various incentives to entice consumers to use their services. Although these incentives have been around for quite some time, they have evolved over the years to keep up with consumers’ ever-so-changing demands.
An example of this type of incentive is when banks attracted consumers by offering gifts, like free toasters, in exchange for opening up new accounts.[2] The times have changed and the prospect to get a free toaster doesn’t seem to work anymore. These days, the incentives that do seem to work are rewards points, cash back incentives, and airline miles. While these types of rewards are usually earned when one uses the credit card for a purchase, many banks and hotel services will offer initial bonus points just for signing up, hence the incentive to pick their specific credit card. The IRS has yet to decide whether rewards points earned just for signing up are considered “income” for federal income tax purposes.
The Internal Revenue Code defines an individual’s gross income as “all income from whatever source derived.”[3] The code includes a non-exhaustive list but does not mention anything about credit card rewards.[4] It would seem that from the phrase “whatever source derived” that these rewards points would in fact be included as income since they are derived from a source—the bank or credit card provider. However, the grey matter is not in the latter half of the sentence, but rather the first half. Income tax can only tax income and the legal issue is whether these rewards points are considered income.
What makes this more confusing is that even if the rewards points are to be considered taxable income, how would one determine the value of such rewards? Cash back is easy to compute because it is merely a percentage of what was spent. Rewards points and travel miles, on the other hand, are difficult to calculate because there is no standardized value to their worth. One may say the value that the consumer is able to get when they sell their points back to the provider is a good indicator. However, such a method isn’t a true indicator of worth because the provider will often buy back the points at a lower than market value.[5] On the other hand, that same reward may have a substantially higher worth when actually redeemed to purchase flights.[6] There is also a secondary market where people sell their rewards points for cash, often doing so against the wishes of the airline companies.[7] The multitude of options and values make it difficult to compute the fair market value of the reward points.
General practice indicates that reward points do not constitute “income” for income tax purposes.[8] When one makes a purchase, and receives a percentage of the transaction back in cash, the IRS considers this to be a discount and not income.[9] It is no different than purchasing a printer in cash and sending in the rebate to the manufacturer to get the cash back. It is not income, but rather a rebate or discount. Furthermore, many credit card companies will offer initial travel miles or rewards points, if and only if, one charges a predetermined amount within a set time (i.e. five hundred dollars of purchases within three months). This is generally not considered income, but is a discount or rebate similar to cash back (the only difference is receiving payment-in-kind instead of cash).[10]
A bigger issue arises when there is no rebate or discount, but rather a free bonus for signing up for a credit card without the need for an initial charge requirement. It seems that the IRS does consider this to be taxable income.[11] For example, in 2012, when Citi Bank sent 1099-MISC Forms to customers who received frequent flier miles for merely opening up bank accounts.[12] A 1099-MISC Form is usually given to someone who received a payment of $600 or more from a person or entity.[13] Citi Bank did say that this was only because the consumers opened checking accounts;[14] implying that credit cards are materially different. However, Bank of America “added disclosures about 1099’s to its credit card terms and conditions, making some consumers wonder whether they might be getting tax forms on those too.”[15]
Consumers should always prepare for potential taxations on free rewards points. Although it is unlikely that such a reward will be taxed, consumers should always pay attention to any forms or notices they receive from their banks, credit cards, and yes, even the IRS.
[1] Total System Services, 2016 U.S. Consumer Payment Study, 6 (2016), http://www.tsys.com/Assets/TSYS/downloads/rs_2016-us-consumer-payment-study.pdf.
[2] See Paul Krugman, Opinion, The Market Mystique, N.Y. Times (Mar. 26, 2009), http://www.nytimes.com/2009/03/27/opinion/27krugman.html?_r=1.
[3] I.R.C. § 61 (2012).
[4] Id.
[5] See Claire Tsosie, Credit Card Rewards Aren’t Taxes – If You Earn Them, U.S. News World Report (Mar. 21, 2016, 10:25 A.M.), https://creditcards.usnews.com/credit-card-rewards-arent-taxable-if-you-earn-them.
[6] See Id.
[7] Elliot Rodriguez, Selling Frequent Flyer Miles Can Earn You Cash But It’s Risky, CBS Miami (July 18, 2014, 11:30 P.M.), http://miami.cbslocal.com/2014/07/18/selling-frequent-flyer-miles-can-earn-you-cash-but-its-risky/.
[8] Cf. Janna Herron, Do Credit Card Rewards Count as Taxable Income? Bankrate (Nov. 6, 2013), http://www.bankrate.com/finance/credit-cards/credit-card-rewards-count-taxable-income.aspx.
[9] Are Credit Card Rewards Considerable Taxable Income by the IRS?, Investopedia (Nov. 2014), http://www.investopedia.com/ask/answers/110614/are-credit-card-rewards-considered-taxable-income-irs.asp.
[10] Id.
[11] Id.
[12] Claire Tsosie, Credit Card Rewards Aren’t Taxes – If You Earn Them, U.S. News World Report (Mar. 21, 2016, 10:25 A.M.), https://creditcards.usnews.com/credit-card-rewards-arent-taxable-if-you-earn-them.
[13] What Is the IRS Form 1099-MISC, Turbotax (2016), https://turbotax.intuit.com/tax-tools/tax-tips/Taxes-101/What-Is-the-IRS-Form-1099-MISC-/INF15260.html.
[14] Tsosie, supra note 12.
[15] Id.
