Are reward points taxable or not? Yes.

Different rewards mean different IRS rules

Are credit card rewards taxable? Probably not, but ... Niyazz/iStock/Getty Images Plus/Getty Images

 

Are credit card rewards taxable? Probably not, but ... Niyazz/iStock/Getty Images Plus/Getty Images

Reward points are rampant. Open a new bank account, you’ll get bonus points. Switch to a new credit card, you’re rewarded with more points.

And depending on how you receive the points, you could owe tax on their value.

The key is whether you spent money to get the reward points or if you got them for simply opening an account.

Tax-free rebate treatment
When your points are based on purchases you make, the Internal Revenue Service considers them nontaxable rebates. They are, in the IRS’ eyes, simply a reduction in the price you paid for goods or services.

“When you spend money with a credit card and get reward points, it’s considered a rebate,” says Laurie Ziegler, an enrolled agent with Sass Accounting in Saukville, Wisconsin. “You spent something to get something.”

This has been the IRS’ position since 2002 when it issued Announcement 2002-18.

That document dealt specifically with the taxability of miles earned in an airline’s frequent flier program. Since then, reward points have proliferated, but the IRS has held firm to its 14-year-old decision to not tax these perks.

Credit card points are viewed the same way as the mileage rewards that prompted the IRS original taxability stance.

“Spending $1,000 to get $10 in points is seen as a discount and is nontaxable,” says enrolled agent Morris Armstrong of Armstrong Financial Strategies* in Danbury, Connecticut. “Don’t worry about [taxes on] reward points or any loyalty points.”

Taxable lures to change accounts
But there is some reason to worry about points offered as enticements to switch or open a new account.

Spending $1,000 to get $10 in points is seen as a discount and is nontaxable. Don’t worry about [taxes on] reward points or any loyalty points.

— Morris Armstrong
Enrolled agent, Morris Financial

That was the case in 2011, when Citibank offered customers airline miles for opening a checking or savings account. The next year, those new account owners received 1099-MISC tax documents reporting the value of the miles they received as income.

The IRS got copies of the 1099s, too, and when one of the Citibank customers decided not to report the $668 associated with redemption of the thank you miles, the tax agency demanded he include the amount and recalculate his tax bill.

Instead, Parimal Shankar and his wife Malti Trivedi, took the case to Tax Court. They lost.

Here comes the tax judge
Tax Court Judge Halpern said in his Aug. 26, 2014, decision that the couple must count as income the value of the airline ticket they received by redeeming their Citibank “thank you” award points.

The judge cited the 2002 frequent flier mileage standard when it comes to taxing rewards. But the distinction in Shankar’s case, according to the court, was that “We are dealing here with a premium for making a deposit into, or maintaining a balance in, a bank account.”

In other words, ruled Halpern, something was given in exchange for Shankar depositing money in the bank, and in this case the points were the equivalent of interest on the money.

And, according to the court, the receipt of interest, whether as cash or as subsequently redeemed mileage rewards, constitutes taxable income.

Credit card point differences
Will points used to woo card holders to switch to another piece of plastic be taxed, too?

Based on the tax court decision, that’s possible, but not likely. The distinction between spending to get rewards and simply getting a bonus for switching comes into play here.

Even though a credit card reward might be called a sign-up bonus, cardholders typically don’t get the reward miles or points just for signing up for a card. Instead, they must meet a certain level of spending on the card in the first few months before the promised miles or points are actually put into the account.

Where spending is required before points are awarded, the bonus then becomes a nontaxable rebate. To ensure you don’t get caught in a reward points tax trap, read the fine print before you opt for a new credit card or bank account.

And if you do get an unexpected 1099, don’t ignore it like Shankar did. Armed with such documentation, the IRS will come to you with questions about the income.

See related: Best credit card signup bonuses, 1099-C surprise: Canceled debt often taxable as income

*Correction: As originally published, the name of Armstrong Financial Strategies was misstated. See CreditCards.com’s corrections policy.


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Updated: 11-24-2017