Do you want ((THE)) cancer? (do you want the can, sir?)

(I am neither an accountant nor a lawyer )

Before you applaud this ruling too loudly, this may be a case of “Be careful what you ask for.”

Although it applies only to the Canadian tax system, one would hope that the reasoning would find favor in the U.S. system as well. There is one potential problem in applying it to the U.S. tax system, though, and that is the source of the miles one is using to “pay” for the flight.

If the miles are earned by the individual from private activity (personal flights, personal purchases, application for or use of one’s personal credit card, applying for a home mortgage, etc.,) the miles would be considered to have been paid for by the individual (or whoever paid for the ticket for the personal flight). That shouldn’t present a problem. Nor should the case where the individual has received the miles as a bona-fide gift, or has purchased them from the airlines.

The potential problem arises if the miles were received as a result of business travel paid (or reimbursed) by the employer. The rule is that the value of benefits received as a result of employment (e.g., use of a company car for private purposes, free lunches in the company cafeteria, etc.) are generally taxable as income to the employee. For a long time, there was a question as to whether this general rule applies also to frequent flyer miles received because of official or business travel paid for by the employer.

In 2002 the IRS issued an announcement (IRS Announcement 2002-18) saying that they would “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.”

For that reason, if you use frequent flyer miles you earned on business travel to buy a ticket to fly to Michigan to surprise your Aunt Hattie on her 75th birthday, the value of that ticket wouldn’t have to be reported as income.

However, the IRS announcement didn’t say the miles weren’t income, it just said if you didn’t report it the IRS wouldn’t go after you. The announcement added this important caveat:

“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.”

In the reported case, the taxpayer was claiming the value of the ticket purchased with the miles (or of the miles themselves) as a deduction to reduce his taxes. The question is whether the IRS would see that as “tax avoidance” within the meaning of their caveat, since the miles have been used to generate a reduction of taxes owed.

Interesting question. I don’t have an answer, although I do have some trepidations.

NOTE: This is not intended as legal advice or tax advice.