With competition between banks stiffer than ever for attracting new credit cardholders, many credit card companies are really upping their game when it comes to incentives and rewards for opening new accounts. For those savvy to the credit card rewards game, there has seldom been a better time to get goodies for using your plastic. You might think that there could be no downside to bonuses from your credit card company, but think again. Depending on what the reward is and how much it is worth, you might be on the hook for paying taxes on it. The IRS is sending a message to consumers across America, and that message is: don’t think you can get away with not claiming your freebies.
Let me say one thing off the bat, for those of you clutching your pearls and freaking out on the other side of the computer screen: credit card rewards points themselves are not taxable. If you use your rewards cards strategically to game the best virtual income this way, rest easy. Depending on how you obtain them, rewards may be taxable as income, according to tax experts and the Internal Revenue Service. People who covet and collect rewards can rest easy. The traditional rewards points earned when making purchases with credit cards or debit cards are still tax-free. It’s credit card reward point ‘gifts’ that are taxable, says the IRS.
To differentiate, think about the perks and goodies that are given away as part of recruitment drives for new banking accounts of all sorts. The value or worth of these promotions is considered income, and if it exceeds six hundred dollars, banks are required to send 1099 tax notices to both the IRS and the rewards recipient. Depending on the taxpayer’s deductions, tax bracket and other income, the rewards bonus could turn into tax liability. Mark Steber, chief tax officer for Jackson Hewitt, the nationwide tax preparation service, warns that, with the “scope, the size, the simple magnitude of the gifts… all increasing,” more and more taxpayers may be on the hook without even realizing it.
Banks have seriously upped their levels of rewards in the face of revenue losses over the past two years courtesy of federal regulators cracking down on abuses in the financial industry. Banks can no longer count on billions of bucks in income from overdraft fees, late fees, overlimit penalties, and the interchange fees that used to go cha-ching cha-ching each and every time that a cardholder swiped their debit card at the point of sale. Banks are now pretty desperate to re-accumulate lost business. One way that has sprung up in popularity is offering tempting incentives to customers who commit to opening new rewards accounts. The most common? Giving away twenty-five- to forty thousand free rewards miles or points to new customers who meet purchase thresholds in the first ninety days after signup.
The competition for consumer sign-ups is turning into something of an arms race, says Steber, with credit card companies vying to outdo one another with bonuses. These companies desire customers: their services, their deposits, and their card purchases. They are willing to go to extremes to get them, and that means offering bigger and bigger rewards. They are all trying to outdo one another, and the customer wins from this competition. Well, kind of.
The IRS has never really had to pay much attention to credit card rewards sign-up bonuses before now, for two main reasons. First of all, up until recently, the type of rewards classified as income rarely – if ever – met the six hundred dollar threshold at which issuers had to report them. Secondly, the very type of reward that people are receiving the most – the points that they accumulate for big trips or splashy merchandise – have been earned as the result of the consumer making purchases with a credit or debit card. Citi spokeswoman Emily Collins points out that “rewards and airline miles that are provided in connection with a purchase on a credit card are routinely not subject to individual income tax reporting,” Citi spokeswoman Emily Collins, said in an e-mailed statement. And yet, on the other side of the coin, when a consumer receives some sort of a gift or incentive for opening a checking account “whether cash, a toaster or airline miles,” as Collins puts it – the value of that gift is, in fact, almost always considered to be income and therefore subject to being reported. This is a unique, distinct entity from miles or points earned by credit card customers for their purchases. It’s a picky distinction, but one that counts to the IRS.
Citibank blew the issue open and put it at the forefront of public attention when it sent out a flurry of 1099-MISC notices to customers who took advantage of a 2011 Citi promotion that offered 25,000 American Airlines frequent flier miles to anyone who opened a new bank account. One such customer told Bankrate.com that he was deeply surprised to see the notice showing six hundred forty-five dollars in “income” for the frequent flier miles. Citi, on the other hand, claims that the standard disclosure found in the terms and conditions of its promotions and on its ThankYou rewards program website makes this statement: “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.” The disclosure goes on to spell out the fact that, in accordance with federal tax code, Citibank may be required to file a 1099 form with both the consumer and the IRS for the tax year in which rewards were issued, and that customers are “solely responsible for any personal tax liability arising out of the redemption of ThankYou Points.”
An IRS spokeswoman, Michelle Elderidge, confirmed that Citi’s procedures for reporting were the right ones. Frequent flier miles given away as a “premium” for the opening of a new account can, in fact be considered taxable, she stated. Elderidge urged all rewards card customers to consult with a tax prep professional to determine what, if any liabilities they might have for rewards gifts they received in the past tax year. She stated that customers who have more than one account with a bank or who received multiple rewards for different promotions would receive a 1099 for the total amount received during the tax year. She points out: “The IRS also notes that information on a particular Form 1099 may include various different sources of income from the issuer.”
Tax experts say that being issued a 1099 for credit cards reward “income” is quite rare, and that there is little chance that Citi’s 1099s impacted more than a few of its customer base. Eric L. Green, a tax attorney with the Convicer & Percy law firm in Connecticut quoted by CreditCards.com, states that he has “yet to see” any of his clients receive a 1099 in conjunction with a rewards program. He disagrees with the section of law that would, theoretically, count such rewards as income in the first place. He states that credit card companies give consumers something of value – which, “in theory, would be income.” Still, says expert Steber, don’t take such statements as carte blanche to ignore a 1099 from a bank if one is sent to you. Nowadays, the IRS is quite efficient at tracking income. Should a taxpayer fail to report a 1099 income that has been submitted, they could easily trigger an IRS letter and the threat of a penalty.
Traditional rewards that many rewards card users have come to love are still safe and tax free because they are tied to purchasing something with a payment card. Many of the promotions currently on the market offer rewards points to sign up for credit cards with a caveat that the applicant must make a minimum amount of purchases within the first few months of opening an account. Those rewards are contingent upon spending. Steber explains the difference thusly: traditional rewards are “considered a reimbursement of the fees that you’re paying in association with being a member. It’s a rebate of your fees.” This structure, he says, accounts for the way that a great many rewards programs are set up.
The tax liability comes in when the reward is not tied to purchases you have made. This puts credit card rewards in the same category as prizes you might win on a TV game show, or those fabulous presents given away by talk show hosts like Oprah Winfrey or Ellen Degeneres. If these gifts exceed six hundred dollars in value, they must be claimed. It was a lesson that Winfrey’s studio audience learned the hard way in 2004, when everyone received a new car. The IRS said those are taxable property windfalls,” Steber says. “That’s what this [rewards gift] falls into.” You are so excited about winning a new car that you don’t register anything but happiness, he says, but you end up owing about seven thousand dollars – a rough estimate of the taxes on an average new car – and may not know it until April.
An interesting fact to emerge from the examination of this phenomenon is the realization that many banks simply don’t bother to get involved in reward income reporting, figuring that customers can figure out the tax implications of their swag on their own. Wells Fargo doesn’t offer rewards points for signing on for new credit cards, says spokeswoman Lisa B. Westermann. “Our giveaway for opening a checking account is usually a plush pony, which wouldn’t require a 1099,” she says. Wells Fargo’s disclosure reads: “Any tax liability, including applicable state sales tax and state and federal disclosures, connected with the receipt or use of a reward is your or the reward recipient’s responsibility.” At Discover Financial Services, customers earn cash back bonuses when they use their Discover More and Open Road cards. The bonus points can be redeemed for statement credits, gift cards, merchandise or to donate to a charity. It’s not that nobody considers credit card rewards to be income, as attorney Green stated – it’s that they simply don’t care.
Discover spokesman Matthew Towson explains that, with the Discover Miles card, customers earn air mileage points. With every ten thousand miles accumulated, customers have the option to trade in their points for one hundred dollars off the price of an airline ticket or redemption for gift cards or similar value. He states that the cash back bonus itself is not taxable per federal law, since it is technically considered a rebate and therefore not subject to taxation.
This brings up another salient point in the issue of credit card rewards and taxation, which is the value of non-currency rewards like points. To wit: how much does 25,000 in airlines miles equate to in dollars? Citi’s policy says: “The valuation of ThankYou Point redemptions for Form 1099-MISC tax reporting purposes will be at Citibank’s sole discretion.” Steber from Jackson Hewitt says the valuation is “complicated on a good day … You value it when you have the unrestricted right to it or when you have unrestricted use of it. What are miles worth? They may not have any readily ascertainable value.” After all, air prices change drastically. There is no fixed form of valuation.
According to Steber, the rewards tax issue is just part of the larger problem of Americans largely underreporting their income. The only reason Americans would ever even think to report “earnings” from credit card rewards is because the bank in question sends out a 1099 form documenting the gift to the IRS. If the six hundred dollar threshold isn’t met or the bank doesn’t report the gifts, there is a great chance that the IRS will remain clueless about how much taxpayers receive in this manner.
Still, the burden is on taxpayers to accurately report their income – and that includes sources that they might disagree with. Many don’t, but they should. The IRS believes that the underreporting of American income was the single biggest contributor to the tax gap in 2006. That gap is defined as the difference between what Americans owe in taxes and how much they actually pay. In 2006, the most recent year available from the IRS, that gap stood at $450 billion. Of that, $68 billion was from underreported personal income. Steber puts it thusly: if you make money (from your eBay job, your bank, and/or your employer), you have to pay taxes. End of story.
