In the past, credit card rewards were not taxable. However, a couple’s extreme greed caught the attention of the IRS and set an interesting precedent.
Why credit card rewards are typically not taxable
In general, credit card rewards are not taxable. The reason for this is because the IRS views these rewards as discounts on your purchases. That’s because you earn these rewards when you spend money on products. So, these rewards count as discounts on your purchase rather than income.
As it is more legally described:
“When a payment is made by a seller to a customer as an incentive to buy a property, the payment generally does not constitute income, but is treated as a purchase price adjustment to the base of the property.”
The couple is taxed on credit card rewards in excess of $ 300,000
Here is an interesting decision by the tax court. In 2013 and 2014, a couple made a significant portion of the spending made by American Express Card on the Blue Cash – we’re talking about spending well over $ 6 million.
I don’t talk much about production spend here because it’s not something I do or find particularly enjoyable. But this couple’s example is probably a pretty good illustration of how this concept works:
- The couple had credit cards that offered 5% cashback on certain expense categories
- The couple then bought Visa gift cards with the credit cards (we’re talking about these worth over $ 6 million)
- Then the couple converted the gift cards into money orders
- The pair then profited from the stock market and earned 5% cashback minus some fees
The couple grossed well over $ 300,000 in rewards in two years, though unfortunately the spending caught the attention of the IRS. The IRS has requested the couple post additional income of over $ 312,000 – we’re talking $ 35,665 in 2013 and $ 276,381 in 2014.
The argument here is that in this case, these purchases cannot be considered a purchase price adjustment:
“In this case, however, the petitioners have not bought any goods or real estate to which a base adjustment could apply. Rather, they bought cash equivalents in the form of Visa gift cards, reloads for the Green Dot card, and money orders for which no such adjustment can apply. As a result, the premium dollars paid to petitioners as a settlement credit for cash equivalents fees are an addition to property and income for the petitioners. “
The court made an interesting distinction here and decided that:
- Rewards related to the purchase of Visa Gift Cards do not count as income
- Rewards related to direct purchases of money orders and reloadable gift cards count as income
As the judgment further explains:
“This case rests precisely on the legal gap between the rationale of the general definition of income and the respondent’s own policies. The petitioners’ aggressive efforts to generate premium dollars have created a dilemma for respondents, largely due to the vagueness of the IRS credit card rewards guidelines. The petitioners have clearly achieved economic benefits by sending the rewards program and tirelessly manipulating it. Your actions have never offended American Express, and had Mr. Anikeev not been so successful in his endeavors, he would likely have been ignored by the IRS. However, the extent of its success in acquiring rewards makes this case an extreme test of the longstanding non-taxability of credit card rewards programs. In order to avoid violating his own longstanding policy, the respondent tries to apply the concept of cash equivalence. As we are going to explain here, we find that it doesn’t fit well. “
My take on this case
I’m not a lawyer or a tax advisor, just someone who likes points. 😉 Personally, I don’t think this will make all credit card rewards taxable, although I have a few thoughts on it:
- Primarily, this seems to me to be one of those situations where extreme greed backfires
- This seems to be in line with the IRS stance that premiums generated when no goods or services are purchased are taxable. This also corresponds to the taxation of bonuses for credit card recipients
- It’s not surprising, but I’m curious to see how exactly the IRS got involved – did Amex report it, did the bank that deposited the millions of dollars in money orders report them, or was a red flag hoisted in some other way?
- It’s amazing to me that American Express didn’t close it earlier. They didn’t have particularly high credit limits. How did such millions of dollars fly under the radar for so long?
- The distinction between Visa Gift Cards and Money Orders / Refillable Gift Cards is interesting. I’m curious to see if credit card companies will crack down on this type of purchase in the future
Credit card rewards have historically not been taxable as they have been viewed as a discount on a purchase rather than income. One couple took this to the extreme, spending millions of dollars in manufacturing to generate over $ 300,000 in rewards.
A tax court ruled that some of these rewards should be considered income as they cannot be considered in good faith as discounts on purchases as no real products have been purchased. In particular, rewards related to direct purchases of money orders and rechargeable gift cards are considered income.
The court ruling seems fair enough. and it appears that the judgment is largely specific to this particular case and should not have too many other implications.
What do you think of this decision by the tax court?
(Tip of the hat for Miles to Memories)