Unless you're new to paying taxes, you probably aren't too surprised when you find out that you have to fork over 10 to 40 percent of your income at tax time - but income just means cold, hard cash, right? We're not talking about credit card rewards, are we?
Some of you probably aren't shocked to hear that, yes, in some cases, you do need to report credit card rewards to the IRS. After all, when you win prizes on a game show, even those are supposed to be reported.
But, still, credit card rewards?
Again, sometimes, yes, you do need to report them, which means that sometimes you don't. Go ahead and beat your head against a wall. We'll wait. And then we'll explain when to report your credit card rewards to the IRS and when you don't have to.
Two things to remember with taxes and credit card rewards
There are two rules of thumb when it comes to your taxes and credit card rewards.
First rule of thumb - no need to report the credit card rewards, if you received them by spending money. If you get credit card rewards in a cash-back program, then the IRS will treat it as a discount. Think of it as clipping coupons. If you clip coupons, and you save money, do you have to report that money to the IRS? Of course not.
When you get credit card rewards for spending money with your credit card, it's a rebate. You're saving money and not earning it.
It's generally the same deal with travel miles that you get as rewards for buying things, says Ken Koenen, an attorney who specializes in taxation, among other things like estate planning and business. He is based out of Peoria, Ariz.
"They are considered to be a discount of purchases rather than income," Koenen says.
Consider this example: During November 2018, you did a bunch of your holiday shopping on Amazon.com with your Bank of America® Cash Rewards credit card and earned 3 percent cash back on $1,000 worth of purchases (you can learn more about this card and its reward structure in our full Bank of America® Cash Rewards credit card review). The IRS views that situation as you receiving a 3 percent discount on all your purchases, so there's no need to report it as income even though you redeemed the earning – in this case, that would be $30 – as a deposit directly into your bank account.
The IRS did, in fact, offer an explanation back in a 2002 announcement involving the practice of individuals earning frequent-flyer miles or promotional benefits as a result of using an airline credit card for their business travel.
"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 [sic] miles or other in-kind promotional benefits attributable to the taxpayer's business or official travel," the agency wrote in the announcement.
Second rule of thumb - report the credit card rewards if you didn't spend money to get them. But if the credit card rewards points or travel miles come in the form of a mammoth-sized signup bonus that you can then use to purchase things, then the IRS will see that as income, according to Koenen.
"Because it's not related to a purchase," he says.
Let's look at an example: Let's say you are intrigued by Chase Freedom Flex℠'s intro offer through which you earn a $200 bonus after spending $500 in the first three months of opening an account. That $200 isn't directly tied to the amount you spent, so it's considered income.
The same rule applies for things like a bonus you receive for opening a checking account with a particular bank or receiving a bonus for adding an authorized user to your credit card account.
Best to talk to a tax professional if you have credit card rewards and a business
So what happens if you get a bunch of frequent flyer miles, and you use them to go toward a business trip? Let's say you get 5,000 frequent flier miles, but you have a 10,000-mile round-trip. The trip would have cost $10,000 (we're using easy numbers for the math-challenged), but thanks to those frequent flyer miles, you only paid $5,000. Can you tell the IRS that the flights cost $10,000 and write off the full amount as a business expense?
Not a good idea, according to Josh Zimmelman, owner of Westwood Tax & Consulting, a NYC-based accounting firm that specializes in working with millennial clients.
"If you used your frequent flyer miles or credit card points to make a purchase, then you can't deduct the full amount of the purchase," Zimmelman explains. "It's considered a discounted purchase, so you can report the reduction in purchase price and can only expense the amount that was paid for straightaway."
And mixing the business and personal when it comes to credit card rewards programs also isn't likely to go over too well with the IRS.
"If you used a personal credit card to make business-related purchases with the intention of earning points or cashback rewards, and then were reimbursed for the purchases by your employer, but you kept the points, there is a chance that the IRS might view that as abusing the system," Zimmelman cautions.
That's why, if you're going to get too cute when it comes to your credit card rewards and taxes, especially if you have a business, you really should consult a professional to help guide you through the thicket of thorny issues.
It's also one of myriad reasons to have a business credit card that you use only for business purposes.
What if you get a 1099?
If you are fuzzy on whether you should report credit card rewards, there's another big, significant clue that may make it clear that you should report your rewards to the IRS, according to Crystal Stranger, a Los Angeles-based enrolled agent and tax accountant who runs 1stTax.com, an online tax preparation service.
"If your credit card company sends you a 1099 form at the end of the year showing the value of your ticket, then you should certainly report this amount as income," Stranger says, citing a tax court case on this topic.
She says that a couple years ago, Citibank issued a Form 1099 to some taxpayers after they received 50,000 miles for opening a Citibank account. For whatever reason, however, the taxpayers didn't report the miles.
"Subsequently, they were audited, and it was determined that this amount should have been reported on their taxes as 'miscellaneous other' income. Lesson learned," Stranger says.
The IRS requires companies to report via 1099s amounts totaling $600 or more, which means you're unlikely to receive one even if you did take advantage of a signup bonus. That said, the IRS expects you to report the income even if you don't receive a 1099.
Confusing? Since when weren't taxes confusing?
In the end, if there's any question in your mind, your best bet is to consult a tax professional, but the bottom line is that your day-to-day rewards earned through making purchases are likely in the clear. You should probably look into the situation, however, if you took advantage of a signup bonus in the past year.