Do you remember the story of Konstantin and Nadezhda Anikeev? The couple caught the limelight in 2021 when the IRS contented them for owing taxes of more than $300,000 on their earnings from credit card rewards in 2013-2014. Anikeev later dragged the case to the court, and the judge ruled that most of the rewards were not taxable as they were rebates, not income. However, the points they earned for purchasing cash equivalents were declared taxable.
The case points to confusion – do you need to pay tax for your credit card earnings? The question seems contextual in this full-swing tax season. When figuring out your income, your credit card rewards may confuse you. With considerably higher cashback payouts (up to 6%), they may help you earn some chunks of bucks. But from a tax payers’ standpoint, you may find them ambiguous.
What’s more challenging, the Internal Revenue System (IRS) hasn’t given any clear guidelines on how credit card rewards will be treated. This article aims to clear the air and help you understand the truth behind the taxability of credit card rewards. Read on!
Credit Card Rewards – When Are They Taxable?
Well, credit card rewards are taxable, but not always. The taxability of your rewards depends on how you earn them. For example, if you have opened a bank account with earned cash or miles, you may need to pay taxes on the earned amount. The IRS will consider it taxable income as you haven’t earned the rewards by spending your money.
Following are some bite-sized pieces that help you understand when your credit card rewards are taxable and when they are exempted.
Types of Rewards
Before delving into their taxability, it’s crucial to understand the types of credit card rewards. There are different types of credit card rewards ranging from cashback and transferable points to airline miles. However, from a taxpayer’s standpoint, they fall into two dedicated categories.
- Rewards that are seen as rebates on spending
- Rewards that are considered income for carrying out a particular action
When it comes to redemption, both types are identical. However, considering the IRS perspective, these two categories are different. The cash value of the rewards considered rebates is not taxable.
On the other hand, income-labeled rewards are taxable and identical to any conventional income – just like your salary or wages.
Credit Card Rewards That Are Considered as Income
Here are some rewards that are considered income.
Referral Bonuses
Almost every US citizen knows the “refer a friend” bonus concept. In fact, for many consumers, they are an excellent way to earn extra cash ahead of the holidays. These referral bonuses enable you to earn points, miles, or cashback for referring someone for a credit card you hold. The person you refer requires to apply through the link you send. Once they get the approval for the card, you become eligible to receive the bonus.
Generally, you may earn up to $50 for each referral. What’s more, you can earn referrals multiple times until you reach the annual threshold set by your card issuer. Holding several credit cards from different issuers and sending multiple referrals may earn many bonuses totaling over $500. Most major credit card issuers, like Amex, Discover, Capital One, etc., offer satisfactory referral bonuses.
The IRS considers these rewards’ income’ as they are issued because you have performed a task. In fact, you have helped the bank to acquire new customers by selling their products. Thus, they let you earn a commission. Hence, this turns into taxable income.
Bank Account Sign-up Bonuses
While you may find earning money to open a new bank account exciting, it’s crucial to scan the fine print for pitfalls. The bonuses may not look that big when you pay taxes on them. Every cash bonus you receive for signing up for new accounts is considered fair game by the IRS. You are helping the bank to earn; in turn, it’s giving you a commission. Therefore, you will need to pay tax on the earned money.
1099 – MISC Form
When the IRS sees your bonuses as income, you may need to fill up a 1099 miscellaneous income tax form. This form usually summarizes the total earnings you must disclose while filing your annual taxes. Often, you may miss receiving a 1099 MISC form when you earn less than $500 from bonuses. However, you must still disclose your earnings when filing the return and pay appropriate taxes.
Rewards That Are Not Income
Breathe! You don’t need to pay tax on whatever you earn from your credit cards. There are several points and miles that the IRS doesn’t consider income. Hence, they are tax exempted. Following are the rewards that are truly rewarding (from a taxpayer’s perspective).
Airline Miles
The miles or points you earn from your travel tickets are usually tax exempted. If you have gotten those rewards for personal travel, they are seen as rebates. However, miles you earn from government or business travel may technically be counted as income.
The IRS issued some guidelines in 2002, but there are several details to figure out before they can be implemented. The IRS has been working on them for almost two decades now, and tax implementation may take place in the future.
Credit Card Rewards
Usually, points, miles, or cashbacks you earn from your credit card are tax exempted. When you spend your own money to purchase something and earn points, rewards, or cashback, the IRS counts them as discounts or rebates. Thus, you don’t need to pay taxes on them.
This includes the welcome bonuses you receive for getting a new credit card, as you generally get it after spending a specific amount or making certain transactions.
However, in some specific circumstances, credit card rewards may be taxable. For example, when you use your card to purchase cash equivalents like money orders or debit card reloads and earn rewards, they may be taxable.
What About Business Credit Cards?
Usually, business credit card rewards are not taxable as the IRS doesn’t count them as income. According to the IRS, the cashbacks you earn with business credit cards are tax exempted if you earn them as a percentage of your spending. The IRS has been a little generous with business credit cards as the said rule also applies to other types of rewards that you earn using your business credit card. They include rebates, airline miles, hotel points, etc.
The IRS says that the benefits of business credit cards feature several complications. They make it complex to figure out how and when the income could be valued and how to determine personal use benefits attributable to business expenditures. Due to this confusion, no specific guideline makes business credit card earnings taxable.
However, while the rewards earned with business credit cards are not taxable, the awards may be.
Business Credit Card Taxability – Awards vs. Rewards
The IRS counts your earnings on spending as rewards. On the other hand, cashbacks or bonuses that you earn without spending your money are considered awards, and they are taxable.
For example, the bank account bonuses you earn for opening a new account using your business credit card are taxable. Here you don’t need to spend money to earn them. Hence, they are not technical rebates. Like consumer credit cards, you may need to fill up a 1099-INT form to declare the stated income.
Understanding the Taxability of the Rewards Earned for Paying Business Expenses
Usually, there is no technical difference between paying expenses with a credit card and paying them off using other modes like cheques or cash. However, when it comes to using your credit card rewards to cover your business purchases, there are some crucial things to consider.
Particularly, you can’t deduct business-related purchases as business expenses when you pay them with your credit card rewards. For instance, if you are paying for your $1000 flight for a business meeting using your earned miles, you are not eligible to deduct the cost as a business expense on your taxes as you haven’t paid the money from your pocket.
If you had paid a percentage of the flight fare using cash, you could have deducted the amount as a business expense.
Taxation and Credit Card Cash Rewards – A Quick Case Study
Now that you have learned about general and business credit card rewards and their taxability, here’s a brief case study that clarifies the concept further.
In 2021 (November), a renowned publication reported that the justice and treasury departments have started investigating American Express as the credit card issuer launched a campaign that advised business owners to use the fee-based wire service of Amex and deduct the cost as a business expense. The business owners could then see the cash rewards obtained from the transaction tax exempted on a personal credit card.
Amex used the strategy from 2018-2020, and its primary targets were small businesses that refused to accept Amex cards because of its elevated liabilities. Companies who used Amex wire services for making payments were liable to pay a variable service fee of 1.77-3.5% per transaction as business expenses on the tax return.
The organization introduced those debated reward points to encourage business professionals to use Amex. Those reward points could be used for making wire transactions, and business owners could transfer them to a personal Amex credit card and convert them into real cash.
How did the IRS React?
This specific feature fueled all the chaos. While the IRS hardly counts reward points from personal purchases as income, they need to be generated in the form of points. Whenever you receive them as cash, they will be counted as income. Thus, they will fall under tax liability.
As Amex was encouraging the business owners to acquire purchases on behalf of their company and then turning the points into hard cash as an individual, things turned up muddy, and the rewards became identical to unearned income – not a rebate. Amex, however, discontinued this strategy in 2020, and they appointed law personnel to execute an investigation to figure out the dispute with the said policy.
Later, the company admitted that its strategy somehow failed to uphold its values. Besides, it featured certain inappropriately positioned products with misleading or vague tax benefits. Last year, the IRS took direct involvement in the matter and started probing Amex. This case study can be an excellent reminder when it comes to using credit card rewards and understanding their taxability.
Frequently Asked Questions
Do you receive 1099-MISC for credit card rewards?
Yes, you may receive a 1099-MISC form when your credit card earnings are taxable. If you are unable to figure it out, you should seek advice from a professional.
Can you claim your credit card rewards as your income?
While there are no clear guidelines from the IRS on this specific topic, you should leave it to the interpretation. Usually, all rebates are non-taxable, and all earned cashbacks for completing a specific task are taxable income. In a nutshell, when you make any true exchange of cash, like earning a sign-up bonus, you should declare it as your taxable income.
Can you use your credit card to pay taxes?
Of course, you can. However, there may be certain fees associated.
Endnote
To summarize, whether or not you need to pay taxes on your credit card earnings depends on how you have earned the rewards. Usually, every transaction that involves actual cash exchange is counted as taxable income. On the other hand, when you earn rewards because you have to spend money, they are counted as rebates or discounts. Such rewards are always non-taxable.
