Citibank caused quite a stir a week ago when they started sending out 1099s to folks who had received large quantities of bonus miles for opening accounts. Needless to say, there was quite the uproar, with various opinions being shared, ranging from Congress to bloggers. Well, a week has passed and the IRS have finally clarified its position. Sortof. Things are still not incredibly clear, though it is readily apparent that the IRS sees some miles as taxable and not at a particularly favorable rate.
Michelle Elridge, an IRS spokeswoman is quoted in that LA Times column as offering up three very specific bits of information about points and their taxability:
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.
This part is pretty clear, though not necessarily what most folks want to hear. It suggests that Citi was correct to be sending out the 1099s and reporting the tax liability. The particularly interesting bit is the use of the term "financial account." Not only would this apply to bank accounts, but it could also be reasonably interpreted to apply to credit card and investment accounts as well. After all, those are financial accounts and the points are provided as a premium for opening the account. Not particularly good news for folks who are accustomed to churning CCs and Fidelity/Ameritrade accounts for the huge sign-up bonuses.
As for taxing "regular" levels of mileage earning on CC spend or the actual flying, that’s still safe. The IRS continues to see that as a rebate and not income, so no tax liability there.
A common analogy is buying a $500 television at a retail store and receiving a $50 manufacturer’s rebate. It’s not income, just a deemed reduction of the cost of the television.
The most complicated (and oft-debated) part of the debate might be the valuation of the miles. Many insist that the liability should be the fraction of a cent that the banks pay to buy the points from the airlines. The banks disagree, reporting the value at the full retail price as reported by the airlines. And the IRS is somewhere in the middle.
Under the income tax law the amount of income to the taxpayer is the value of the property received, not the cost that the business paid to acquire the property.
The real gray area there is "value of the property received" which is, by the nature of the property in this case, variable. And it could even be argued that the recipient actually never receives property since the T&Cs of the programs say that the points are the property of the programs. There are others who have explained how to dispute the value reported on the 1099s.
Whatever the approach consumers take, it is clear that the IRS sees these sign-up bonuses as a very different beast from the regular spend earning. And the use of the term "financial account" is very open-ended. The CC churn boondoggle may be coming to an end sooner than we all hoped.
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This makes no sense to me. As part of a credit card signup, I also get the annual fee waived. Is this Citi giving me $89 (or whatever the fee is)? Also, I only get the miles if I spend on the card (usually x miles in x months), so how is this any different than the case of “regular” spend?
Honestly, this looks fraught with loopholes that will require more $$$ for tax accountants and lawyers to figure out. Way to go, IRS.
Sorry, if anyone actually claims these as income, I will be very surprised.
The value of miles/points are variable, and not your property. It will never hold up.
A fee not charged in the first year isn’t exactly the same as a fee credit that could be reported to the IRS.
It confuses me why Citi would send out 1099s for one account (an AA credit card) but not for other accounts (a ThankYou Preferred credit card) when the latter has points that are much easier to value and are being provided by the same organization that issues the card.
The easiest place to start with tax law is basis. Your “basis” is the amount of money that you acquired over the year and is taxable as income of some sort, (capital gains, income, lottery, whatever).
It’s a little different for businesses. Because business both generate revenue and have expenses they are taxable only on the net difference between the two (the profit). IE ABC bank takes in 2 million but spends 1 million on expenses so they are only taxed on the 1 million in “profit”. Yes I know this is an oversimplification but work with me here.
In order for a person to be taxed they have to show some sort of income. Normally this is in the form of a w-2. I worked, therefore I got paid, therefore I have income. This leads to the basic problem with miles. What income do you have when you get miles?
The answer is none. The miles do not have a cash value, so you can not show any income there. The rules on frequent flyer miles are strict. You can’t sell them, barely trade them, and hardly use them. What value do they have? Of course this assume you own the miles to begin with, airlines reserve the right to cancel them if they so chose. But assuming that you own them, lets look at the next problem.
This leads to problem number two, you can use miles for travel. Yes, yes can do that. The airline will take your hard earned miles and give you an airline ticket. That ticket can be shown to have value, in the case of premium cabin travel it can be quite a lot of value. Premium tickets for those that are not in the know can run upwards of $15,000 round trip.
But this leads us back to the fundamentals of tax law. The AIRLINE is the one providing value for the miles, not the issuer of the miles.
Lets look at the individual transactions:
XYZ Air issues one million miles to ABC Bank at $1.00 each. Here the airline has generated 1,000,000 in ABC and must pay tax on it.
Before, ABC bank issues the miles to Joe Consumer, and Joe goes back to the airline to get his free ticket. ABC absorbed the tax hit on the miles because they can’t show the miles as an expense. They bought a million miles but the tax liability didn’t pass through to the consumer. Also the airline took the same hit when Joe redeemed the seat, the airline can’t show the business expense of the redeemed seat because they didn’t pass the tax burden to the consumer.
Bringing it all back to Citi. Citi has decided that they will no longer shoulder the burden of these miles. so the issue a 1099 to the consumer and write-off the value of the miles as a deduction because there was no income they gave it all to the consumer.
In short, Citi is hosing their consumers for a tax write off.
This is the most balanced blog post I have seen on this topic. Most bloggers seem to be engaging in wishful thinking or some type of this-can’t-be or Citi/IRS-is-wrong thinking.
I can not see, even on the new card bonus. As other point out, points have no cash value. Plus, at any time, per the T&C of every airline program, they can, at their discretion, close your account and your points go bye bye. How can you pay tax on something that has no value and can go away without your control. This will not stand IMO for now.
To expand further on deltagoldflyer’s reply, let’s say that for whatever reason you points either expire or are revoked by the loyalty program. In either of these situations would you be allowed to take a tax write-off for the loss?
The Citi 1099s are not limited to “large amounts” of miles. I received one for 5,000 miles, valued at $125. I will pay the tax since I have better things to do with my time than fight with the IRS.
time to avoid Citi offers for this pettiness.
colpuck, that was a long comment which almost lost me. In the end it was an enjoyable take.
I would look at it this way:
Joe Consumer uses his money and buys a RT ticket. Ticket costs $400 and taxes/fees are $25. Transaction closed.
Let’s assume that Joe Consumer uses his miles for a free ticket. The ticket should cost $400, but in effect, 25,000 miles acts as a rebate of $400 and Joe consumer is charged taxes/fees of $25.
There is little difference in the two scenarios.
Gosh, now I might have to stop taking advantage of double manufacturer coupons. My $1.98 saving is greater than the “reglar” $.99 coupon offer.
Anyhow, regular vs sign-up bonus, current value vs future value, etc. In the end I do not see the IRS going after this as departmental costs would increase and the wording is too gray.
A couple of people posted it above, and I think it is worth bolding a little bit…but in order to be taxed on something, don’t you have to “own” it? As airlines have stated, those miles are not owned by the individual, they are owned by the airlines. How can I be taxed on property if I don’t own it?
So my plan is to send Citibank a free gift of 25,000 FictionalMiles. Since I get to set the value of these miles based on my own rules (and not based in reality), I will value this gift as being worth $1 Million, and will send them a 1099 stating such. Citibank will now need to pay taxes on that $1M, even if I have rules that are so strict that they can never redeem those miles.
Thoughts?
Seems like Citi needs to consider the difference between what it paid for the miles and what it is reporting the value of miles given to card holders as taxable profit amd pay taxes on it!
PatB,
Your miles are worthless, so Citibank won’t any tax liability for your so-called gift.
This gets me thinking though. Do we need to pay income tax when we receive subsidized cell phones? E.g., if I pay $400 for my iPhone, but the retail cost is $700, do I have $300 in taxable income?
How about food samples at the grocery store? Do I have $0.03 of income when I sample the chips and dip?
This seems to lead down the rabbit hole pretty quickly.
Scottrick, read the article again – they are issuing 1099’s for AA checking accounts, not credit cards.
And anyone who pays the taxes on miles is a fool. You can write it off as a Fair Market Value adjustment of 0.00$, because you don’t own miles, and they have no cash value. That’s what everyone who does their own research does, instead of reading a flawed, fear-mongering newsrag article as gospel.