Are credit card rewards taxable? Probably not, but ...
The answer from the IRS isn't cut and dried
By Kay Bell
After much deliberation, you settled on a credit card that offers the perfect rewards program. But there's always been that nagging question at the back of your mind: Does Uncle Sam consider my card rewards taxable income?
The short answer is maybe.
The practical answer is probably not.
Wise to worry
Your concern is not unfounded. It's no secret that that the IRS considers as much as it can taxable income. Heck, if the IRS explicity says illegal earnings are taxable (remember Al Capone), why wouldn't it go after your credit card rewards, too?
However, credit card reward programs, be they redeemable points or cash back, are typically considered rebates. And rebates aren't income.
"If you look at this as a rebate or purchase price adjustment, it's not taxable," says Bob D. Scharin, senior tax analyst with the Tax & Accounting business of Thomson Reuters. "For example, you buy a cell phone and mail in a coupon and get a rebate on that price, it's not income. The same rule would apply if you sent in 10 breakfast cereal box tops and got a $10 check in mail. It's a reduction in the purchase price."
Income or price break
You say you're still a bit worried because when it comes to card rewards, the rebate isn't direct. You've got a point.
"The credit card company is not the one you're buying the services from, so it appears that the credit card company is giving you a commission for using the card," says Scharin. "And that appears to be income."
But don't panic. You could argue that rather than providing cardholders income, the credit card company is negotiating a price discount for its customers.
Even more encouraging are a couple of reward-related cases in which the IRS has spelled out, at least to a degree, its apparent inclination to leave these programs off the taxable income list.
Frequent fliers precedent
In Announcement 2002-18, published in Internal Revenue Bulletin No. 2002-10 on March 11, 2002, the agency let frequent fliers off the hook for the miles they accrue via credit card programs.
The IRS stated that it "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." Basically, the tax man is saying while he might have the right to consider the mileage rewards as income, he's not going to do so.
Then in July of 2002, the IRS issued a private letter ruling concerning a cardholder who wanted to donate program points to a charity. In that case, one of the findings was that the rewards, referred to by the IRS as rebates, "are not includible in Taxpayer's gross income."
Too much trouble
Of course, a private letter ruling, as the name suggests, applies to just one, private, tax situation. But these rulings generally are viewed as an indication of IRS thinking in regard to a more general tax issue.
Scharin also points to the phrasing in the air mile case. The IRS said it "would not assert" that taxpayers owe money on the value of the miles.
"Whether that's a strict tax law interpretation or simply a function of 'It's so hard to administer that we're not going to tell people they owe money on this' is the question," says Scharin. "There could be a gap between tax theory and practical application."
For now, the don't-tax position seems to have the upper hand. And for that bit of tax-collection pragmatism, credit card rewards program participants can be thankful.
See related: Compare reward credit cards, Beware of tax bite that follows forgiven debt, 7 ways to get the most from credit card reward programs
Updated: April 8, 2010