It's bad enough we have to turn over anywhere from 10 to 40 percent of our hard-earned income to the federal government at tax time, but some unlucky cardholders may have also received tax forms for their credit card rewards this year.
The question of whether credit card rewards are taxable has been the subject of much debate for years. And what, you might ask, is the verdict? Do we need to pay taxes on our reward points? After thoroughly reviewing the issue, we feel we can confidently say: um, maybe.
The murky world of taxes and credit card rewards
The IRS maintains a laundry list of potentially taxable income items on its website, but credit card rewards are nowhere to be found. This has led to a gray area and disagreement, even among tax professionals, regarding what the law says.
"Technically, anything received of value during a taxable year must be reported as income," says Randy Padawer, consumer advocate at Lexington Law Firm.
Meanwhile, Bob Wheeler, a CPA and author of "The Money Nerve: Navigating the Emotions of Money," says rewards are more akin to non-taxable rebates than to income.
"Currently, the IRS says that the rewards are a reduction of purchase price versus income," he explains.
Over at TaxACT, one of the country's leading online tax prep services, the word is that rewards points are rebates, not income.
"The IRS considers rewards to be a discount on the purchase," says Mark Jaeger, individual tax manager and developer at TaxACT. "For instance, if a cardholder receives 1 percent cash back per purchase, the 1 percent is not taxable because it is a discount on the purchase. If that same person opens a checking account and the bank rewards them with $50, the $50 is considered taxable because nothing was purchased and it is considered an award."
Some card issuers sending 1099s
It may seem like a technicality but the difference between a discount and an award may be what prompted some card issuers to start sending 1099s to high-earning cardholders.
Most notably, Citi made headlines in 2012 after sending 1099 forms to some of its ThankYou Rewards members. The company also includes a notice in the fine print for the program saying rewards may be reported to the IRS as miscellaneous income.
"Citibank issued a 1099 [for sign-on bonuses] because it was an incentive to open an account which is different than earning miles from a flight or purchase," notes Wheeler. "There is a distinction between miles earned and miles awarded as incentive to open an account."
Business frequent-flier miles may be in the clear
While the status of cash-back rewards and merchandise incentives may be up for debate, the IRS has said definitively that some frequent-flier miles are in the clear.
The government agency issued an announcement in 2002 regarding the practice of individuals earning frequent-flier miles or promotional benefits as a result of using an airline card for their business travel. There had apparently been a question about whether these perks added to an individual's income. The answer was no.
"Consistent with prior practice, the IRS will not assert that any taxpayer has understated his federal tax liability by reason of the receipt or personal use of frequent-flier miles or other in-kind promotional benefits attributable to the taxpayer's business or official travel," the agency wrote in the announcement.
Do you need to claim rewards points on your taxes?
With all that said, we come back to one basic question: do you need to claim the value of rewards points on your tax forms? And if you don't, aren't you in trouble if the taxman comes calling?
Even Padawer, who argues the rewards are technically taxable, says not to stress about it.
"As a practical matter," he says, "low-dollar rebates, gambling proceeds, credit card cash back, and airline miles are not considered by the IRS to be a taxable award or prize, even during a formal audit."
That said, Padawer says the IRS might not be so kind in some situations. For example, if you are using your personal cash-back card for business purchases and then being reimbursed, it may be considered an abuse of the system if you fail to claim the cash-back rewards.
To keep yourself in the clear, both Padawer and Wheeler say consulting with a professional might be in order.
"When it's a gray area like this and you think you might be affected," says Wheeler. "I think it's best to track the miles or the information and give it to your tax person and have a discussion to decide the best course of action."