Which Credit Card Rewards Does the IRS Care About?

citibank irs
citibank irs

Citigroup's (C) Citibank recently sent recipients of a special frequent flier mile promotion an unwelcome surprise: a 1099 tax form indicating those bonus miles have been reported to the IRS as income.

Even if you weren't part of that promotion, it's reasonable to wonder whether the frequent flier miles or other credit card rewards you collect are going to cost you, too, come tax time.

The answer appears to be no. The two scenarios are different.

  • In the taxable promotion, Citibank was seeking new customers and those who opened new accounts received 25,000 miles as a reward.

  • In contrast, the regular miles and rewards that we accumulate over time are due to our using our debit or credit cards.

In other words, the former is more akin to a financial gift, while the latter is considered a rebate earned by the customer.

Following in Oprah's Footsteps

This issue is only recently rearing its ugly head because sign-up prizes haven't generally been big enough to trigger reporting. Recent banking reforms, though, have caused banks to see the revenue they were used to collecting from hefty fees for overdrafts, late payments, and debit-card swipes shrink. As a result, they've been shifting their focus and are now competing aggressively for new customers.

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In the case of Citibank's rewards, it valued each mile as worth 2.5 cents, so a 25,000-mile reward was worth $625, and therefore the bank deemed it reportable as taxable income. Thus, Citibank was simply following the IRS' rules, which require the reporting of prizes or awards valued at $600 or more.

The concept of gifts being taxable isn't a new one. In an article at CreditCards.com, Connie Prater offered the famous example of Oprah Winfrey giving those in the audience at one of her show's tapings a free car. That was a thrilling surprise windfall for the lucky attendees, but it caused problems for some, too, as the value of the cars was considered taxable income. If you suddenly receive a $25,000 car, you might find that you have to cough up $6,000 in taxes. You'll still come out ahead, but you'll face a cash crisis if your bank account isn't flush.

Rewards the IRS Usually Ignores

While sizable gifts from banks can indeed be considered taxable income, the rewards that banks give you based on your credit or debit card usage are generally not taxable -- and generally don't even need to be reported to the IRS.

Citibank spokeswoman Emily Collins has explained, "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."

Getting a reward for opening a new account can still be a non-event, tax-wise, if the reward isn't worth $600 or more. A Wells Fargo (WFC) spokeswoman noted that her company's recent giveaway for new accounts was a stuffed animal.

The Big Picture

It's important not only to understand what is and isn't taxable, but also to remember that the world of tax rules is a fluid one. Rules change over time. Indeed, already, Sen. Sherrod Brown (D-Ohio) has called on Citibank to stop treating the frequent flier miles as income. Whether the bank will stop -- or even whether it can, given IRS rules -- remains to be seen.

When it comes to IRS regulations, it's best to follow them -- they're not optional. One area in which Citibank does seem to have some discretion is in how it values its miles. If it valued each mile at $0.02 instead of $0.025, the value of 25,000 miles would have been $500, not $625, and wouldn't have crossed the $600 threshold.

Until further notice, taxpayers who collect rewards for credit- or debit-card use should follow the rules, resting easy about their purchase-related rewards and preparing to report any sizable gifts from banks.

Longtime Motley Fool contributor Selena Maranjian holds no position in any company mentioned. You can follow Selena on Twitter @SelenaMaranjian. Click here to see her holdings and a short bio. The Motley Fool owns shares of Citigroup.

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