Taxation is tricky. We want to simplify it. Today we delve into the ins and out of taxation on credit cards, freebies, gifts and promotions!
“Are my Casey’s 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:
- 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.
- Sign up for __________ credit card, and you will receive 60,000 hotel/airline points after you spend $2,000 in the first 3 months.
- Open a new checking account at __________ bank and you will receive 60,000 hotel/airline points.
- 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.
Let’s take some time to delve deeper into those examples to understand the tax implications of each.
The “Freebies” and the Sign-up Bonuses
Let’s deal with the last two examples, the opening of the checking account and free car events, 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. In many giveaway situations, 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, and it must be reported.
So, what about 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.
While paying taxes isn’t fun, I don’t generally advise clients to make less money or avoid award opportunities in order to avoid paying taxes.
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.
For 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. You can either simply reduce the item expense in your books or, if the $1,000 is spread across multiple categories making it hard to break down, you can report the $250 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.
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.
While the IRS has not released notices that explain their stance on every type of reward out there, in Announcement 2002-18, the IRS said that it will not pursue, at the current time, the taxation of frequent flyer miles.
The most important question to determine the reward’s taxation is “HOW was the reward earned?”
If you get a “sign-up bonus” of 50,000 points for opening a checking account or for simply signing up for a credit card, those points will be taxable. But, the rewards you get as a rebate for purchases 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.
It is this understanding of the difference between “sign-up bonuses” and “purchase rebates” that separates the credit card giants from the rest of us. 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.
So now with this credit card and gift tax code explained, how does it apply for an employee or a business owner?
Let’s say you apply for a credit card for which you receive 70,000 airline points when you spend $3,000. Generally, this is not taxable because the cash value of the points you receive is likely less than the cash you spent. It’s a rebate, not income.
It is important to note that if the money was spent for business expenses, you should be able to use the airline points for personal or business use. No matter what the money was spent on, you can always 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.
Using the same example credit card, if you received 70,000 airline points after having spent $3,000 which was reimbursed to you by your employer or the business you run, things can get a bit tricky and will probably end up being taxable to you.
If 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.
If you are the 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.
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.
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 taxation information presented above is for informational purposes only and not actual accounting, or credit score, advice. If you have additional questions, please contact us today.