Are my credit card rewards taxable? Freebies, Rebates, & Rewards
“Are my pizza box tops taxable!?”
This was the question that popped into my head when I was cleaning one evening and came across 19 box tops. That’s only one short of being able to order 2 large specialty pizzas, at no cost to me! A $32 plus sales tax value!
Now, I understand that I had to do something to receive this reward… purchase 19 large pizzas. This is the way that rewards generally work. Otherwise it would be a gift or something else. So I am not saying it’s a reward that was truly free.
I quickly knew that the answer to my question was “No. It is not taxable.” This is really no different than a Buy-One-Get-One Famous Footwear sale, or being automatically upgraded to the unlimited family pass because we went to the swimming pool 15 times. In events like these, the only cost that will be recorded for business or budgeting purposes is the cash out-of-pocket.
But, what about the credit card rewards that I and thousands of other Americans love so dearly?
Here are two common examples:
- 1) Sign up for __________ credit card, and you will receive a $250 credit to your account after you spend $1,000 in the first 3 months.
- 2) Sign up for __________ credit card, and you will receive 60,000 hotel/airline points after you spend $2,000 in the first 3 months.
I have acquired cards under both of these scenarios, but definitely more heavily on the hotel reward point’s side of the spectrum.
Here are a few more examples that need to be addressed in order to understand the taxability of rewards:
- 3) Open a new checking account at __________ bank and you will receive 60,000 hotel/airline points.
- 4) You are in the studio audience for The Oprah Winfrey Show on September 13, 2004. “You get a car! Everybody gets a car!” Everybody got a car. But not everybody kept it.
Those last two examples are pretty much the same when it comes to tax treatment, despite having very different values. Those events are generally taxable, while the first two events are much less likely to be taxable.
The following will be information to help you understand what’s going on. At the end of the article, I will rapid fire through a bunch of examples so you can see how they will be taxed.
The “Freebies” and the Sign-up Bonuses
Let’s deal with the opening of the checking account and free car events first before we settle in on credit card rewards.
In short, the rewards you get for opening a checking account and depositing $500, attending an event, or winning big at Treasure Island Resort and Casino are taxable.
When the bank gives you an award for opening up that checking account, it’s similar to them paying you interest for letting them use your money, even though it may be a one-time event. I have mainly seen banks give away small rewards such as fancy teddy bears and toiletry packs with their name on the side. I was the cool guy in college pulling my toothbrush out of that free Wells Fargo toiletry pouch in the bathroom.
In many of these cases, the rewards are small and nobody reports anything, so it doesn’t strike people as a tax event. However, in any case when the award given is worth $600 or more, the award giver is required to send 1099-MISC forms to the IRS and the award recipient.
One case that made it to the tax court in 2013, for the 2009 tax year, resulted in the taxpayers paying taxes, interest and penalties because they did not report the income from the 1099-MISC they received from Citibank. The income reported on the 1099-MISC was $668. They opened a checking account and received 50,000 airline points as an award for doing so. Citibank assigned a fair market value of $668 to the 50,000 airline points.
Many would say, “Too bad for them.” Many would say, “The taxes on $668 are much less than the value of the flight the taxpayer was able to take.”
Either way, the taxpayers were upset with the court ruling.
And all those free cars that people received from Oprah? They received the keys to their cars and had the rights to them, but that didn’t stop them from receiving a 1099-MISC for the value of the car they were awarded just for sitting in at Oprah’s show. If the cars were valued at $28,000, a 25% tax would be $7,000.
Again, many would say, “Too bad for them. Now they have to pay taxes.” But many others would say, “You only have to pay $7,000 for a new car!”
Some of the recipients paid the extra tax and kept the car, while others sold the car right away, paid the tax, and pocketed the difference.
Paying taxes isn’t fun, but I don’t generally advise clients to make less money or avoid award opportunities in order to avoid paying taxes. Having to pay taxes is NOT the main reason why most people need to stay away from the casino.
Credit Cards – The “Cash Backs” and the Spending Rewards
Now, onto those wonderful credit card rewards programs.
The first example I mentioned above was when you sign up for a credit card, spend a certain amount of money and then receive a credit to your account. The second example was when you sign up, spend money and then receive points that can be used for something, usually airline or hotel related.
In both of these scenarios, the rewards are treated like rebates and are not taxable. Instead of viewing them as a gain in income, the IRS is seeing them as a discount on the purchases made, just as long as the reward isn’t worth more than the amount spent in order to get the reward.
One note about the credit cards that give cash back in the form of a credit to your account – If you are deducting the cost of the purchase as an expense for a business, then you need to take that reward into account when it comes to reporting your expenses on your business tax return.
Example
If you need to spend $1,000 with your new credit card in order to receive the $250 credit to your account, the actual hit to your pocket is going to be $750 for whatever it was you spent the first $1,000 on using your credit card. So don’t think you can just write off $1,000 as a business expense and not do anything when that $250 credit shows up. I think it makes the most sense to reduce the item expense in your books. But if that $1,000 is spread across multiple categories in a way that would be hard to break down what the credit is actually for, then I could see that $250 being reported as Other Income for the business instead of reducing the reported expenses.
I love these cash-back rewards credit cards when it comes to saving money on necessary purchases. Here’s an example of the power of cash rewards and rebates. I’ll use the same credit card example as before.
I purchase $1,200 worth of new flooring from Menards for my personal residence with my new credit card. Spending $1,000 allows me to get the $250 reward. On top of that, this credit card is also giving me 1% cash back on all purchases forever, like most credit cards (it is pretty easy to find credit cards that give you more than 1% back). And for anybody who is a fan of Menards, you can reasonably guess that I purchased the flooring on an “11% mail-in-rebate on everything” kind of week.
So at the end of the financial transactions surrounding this one event, I’m sitting with the following:
- 1) $1,200 worth of new flooring in my house. I purchased supplies and installed it with a buddy.
- 2 )$938 net-cost to purchase the flooring. $1,200 – 1% - $250.
- 3 )$132 in Menards store credit after mailing in my receipt and waiting patiently. For the biggest of Menards fans out there, $132 in store credit is the same as $132 cash in my pocket.
Unfortunately, this great of a deal doesn’t happen every day in my life. There just aren’t enough credit cards.
A conversation for another time that doesn’t apply to right now is how a 50% mail-in-rebate is not the same as a 50% discount.
Finally, we come to my favorite of the reward credit cards – the airline and hotel points cards.
Without ruining my financial well-being, I have successfully acquired and managed multiple credit cards. I currently have debt and I expect to continue using credit cards for a long time (Dave Ramsey fans can start writing nasty comments on my Facebook page). But I am a baby compared to the credit card giants that are my two older brothers and my father. Those men have flown into more airports and enjoyed more hotels within the last 2 years than many do in their entire lives – and this was all at little to no cost. This is all due to aggressively using reward credit cards to make necessary purchases in normal life and business. It also helps when you can use credit cards to purchase most of the improvements necessary for rehabbing houses to either flip or hold onto as rental properties.
In Announcement 2002-18, the IRS said that it will not pursue, at the current time, the taxation of frequent flyer miles. The IRS has not released notices that explain their stance on every type of reward out there. But it seems like the frequent flyer mile is similar to the frequent Casey’s pizza. You do something enough times, or make enough purchases, you get a bonus reward. The cost of those extra miles is included with the earlier miles. The cost of the 11th pizza is included with the 10 pizzas purchased earlier.
The most important question is “HOW was the reward earned?”
If you get 50,000 bonus points for opening a checking account or for simply signing up for a credit card, those points will be taxable.
The important thing to remember is that the rewards you get as a rebate for purchases made are generally not taxable. This is why a lot of credit card companies give you points after your first purchase is made. It could be a $1.39 coffee from the gas station – they don’t care. It may seem like they are giving an award for simply opening an account, but they are following the rules and saving everyone a headache when it comes to the end of the year. No 1099-MISC form needed.
This difference between “sign-up bonuses” and “purchase rebates” is what the credit card experts out there are looking for. Before they get excited and sign up, they read the information that tells them how the reward is given, how much they need to spend and by when. Then they calculate whether or not it’s feasible and either go for it or hold off.
Summary
Time for a rapid fire list of examples to summarize what’s up:
- 1) Open a checking account. No deposit required. Receive a $300 cash bonus – No 1099-MISC, but it is taxable income.
- 2) Open a checking account. $500 deposit required. Receive a $300 cash bonus – No 1099-MISC. Might receive a 1099-INT, and it is taxable income.
- 3) Open a checking account. $2,000 deposit required. Receive 50,000 airline points valued at $500 – No 1099-MISC, but it is taxable income.
- 4) Open a checking account. $2,000 deposit required. Receive 80,000 airline points valued at $800 – Should receive a 1099-MISC.
- 5) Credit card. Spend $1,000. Receive $250 credit.
- a. If this is for personal expenses, then this is nontaxable.
- b. If this is for business expenses, then the expense and cost basis reported should be reduced.
- 6) Credit card. Spend $3,000. Receive 70,000 airline points – Generally nontaxable. The cash value of the points you receive is likely less than the cash you spent. It’s a rebate, not income.
- a. If the money was spent for business expenses, you should be able to use the airline points for personal or business use.
- b. Whether the money was spent for personal or business expenses, you can use the airline points for business, but cannot deduct what you would have paid for the flight as an expense had you not used the rewards points. You can only deduct what cash actually went out of your pocket.
- 7) Credit card. Spend $3,000 (reimbursed to you by your employer or the business you run). Receive 70,000 airline points – This is where it gets dicey and is probably taxable to you.
- a. You are an employee and use your rewards credit card to pay an expense that you are fully reimbursed for by your employer. You have $0 net-cash invested and 70,000 airline points. This may be hard for the IRS to catch, but this is taxable income.
- b. You are an owner of a business and pay an expense, using your personal credit card, which you are fully reimbursed for by the business. It goes on the business’ books as an expense. You, as the individual, have $0 net-cash invested and 70,000 airline points. Again, hard to catch, but this is taxable. The business should be the owner of those points.
Investors, many of you spend thousands per rehab property multiple times each year. It is less important for you to find that one awesome credit card that you keep forever – utilize the “big-spending-big-rewards” cards. You have the ability to spend a large chunk of money ($3,000 +) in a short amount of time (3 months), maybe even multiple times each year. Many credit cards are great for the short run and not great for the long haul. At some point, when it makes sense credit-wise, cancel the card. You want to eventually cancel the one-time rewards credit cards so that you can avoid annual fees and reduce your overall credit capacity. This will help you in the future when you want to apply for a new card or even a new loan at the bank.
Conclusion
Don’t forget that the most important question you need to answer is “How is the reward earned?” If you can answer this, then you and your tax person have the information needed to plan accordingly.
If you are in a solid financial position, have good spending habits, and think you would enjoy some of those fun rewards – I encourage you to look into some of these rewards credit cards for yourself or for your business. My favorites are:
- 1) Club Carlson (Premier and Business) Rewards Visa
- 2) IHG Rewards Club Mastercard
- 3) Barclaycard Arrival Plus Mastercard
If you have a past of not using self-control when it comes to credit cards, I am not encouraging you to sign up for one now.
But for the financially savvy individuals, entrepreneurs and real estate investors – keep taking advantage of those sweet credit card rewards programs. The tax code might change someday and not be ever in your favor.
Disclaimer – Every individual is different. Please discuss your situation with your tax professional or your attorney when it comes to tax and legal matters. The information presented above is for informational purposes only and not actual accounting, or credit score, advice.
Comments