According to experts, whether cash back and points are taxable depends on the type of card you have and the kind of rewards you earn.
As a rewards credit card holder, you may be wondering if the cash back, miles or points you earned over the last year are considered taxable income.
The IRS taxable and nontaxable income list does not directly address credit card rewards. However, the experts say the answer is based on the kind of rewards you’re accumulating and the kind of credit card you have.
What is the IRS’ stance on credit card rewards?
The IRS’ stance on credit card rewards is outlined in Rev. Rul. 76-96, which states that payments made by a seller to induce a purchase of property are not treated as income but as a purchase price adjustment to the basis of the property purchased. Credit card rewards for purchases of products or services are thus treated as nontaxable purchase rebates.
This policy recognizes that a taxpayer who avails themselves of a discount in acquiring goods and services has no additional accession to wealth, as they have retained more of their wealth than a taxpayer who pays full price.
When are credit card rewards taxable?
You have to spend money to earn regular, ongoing rewards like cash back or travel points. So you’re not really getting “free” money like you would with a cash prize or bonus, which is taxable.
Credit card rewards that are taxable for not requiring an expense in return:
- Welcome bonus that doesn’t require spending a certain amount of money
- Referral bonus
- Cash prize
“Credit card rewards for individuals are usually not taxable,” says Susan Allen, senior manager for tax practice and ethics at the American Institute of Certified Public Accountants.
“The logic is that the reward is almost like using a coupon or getting a discount on the purchase,” Allen says, so by getting cash back, “it’s really like reducing the purchase price.” The same logic applies to travel points and miles.
When are credit card rewards not taxable?
Usually, in order to receive a sign-up bonus, you’ll have to spend a certain amount on the card within a specified time frame. In this case, the reward is still more like a rebate than a prize or award, making it nontaxable.
Credit card rewards that are not taxable because they require an expense in return are:
- Welcome bonus in exchange for spending a certain amount of money
- Cash back and points
- Airline miles
The exception is when you receive a bonus or gift without having to spend any money, like a sum of cash back just for opening an account or a cash bonus for referring a friend. In these cases, the reward is more like a prize or award, which are both taxable.
It’s a different story if you have a business credit card and you use your rewards, such as cash back or a gift card, to help offset your business expenses. While the rewards themselves aren’t taxable, they can reduce your deductible expenses, increasing your tax burden.
According to Meredith Tucker, a principal at the CPA and advisory firm Kaufman Rossin, the example of a business owner who charges $1,000 on their credit card for business travel and uses the $200 they earned in cash back to reduce their out-of-pocket cost to $800. The most they can deduct from their taxes in that situation is $800.
And if you use only your rewards to cover the price of a purchase, you won’t be able to deduct the cost of the item from your business expenses, Tucker says.
As a business owner, you may prefer to use rewards to cover the cost of an item. That way you “don’t have to pay for something, rather than just get a deduction for it,” she says.
Along with tracking your business expenses, business owners need to keep track of how they are using business credit card rewards to offset their business expenses when tax time rolls around.
You also need to pay attention if you open up a new credit card and receive a cash bonus for signing up (rather than meeting a minimum spending requirement), or get cash for referring a friend. That extra cash you scored could be considered taxable income.
“Some credit card issuers may report the bonus as income on (IRS) Form-1099,” which reports miscellaneous income, Allen says. “You would need to report that income on your tax return.”
How do I report taxable rewards when filing my taxes?
If you receive a reward that requires no spending threshold in order to redeem it, it may be considered as taxable income, and you should report it as such on your tax return. If the reward exceeded $600, you would receive a 1099-MISC from the credit card issuer to include with your tax return. Even if you don’t receive a 1099 for it, you still may have to pay taxes, as there’s a catch-all line for reporting other income on your tax return.
“Report on other lines of the appropriate tax return any taxable income that is not specifically reported elsewhere in the return,” the IRS’ website says.
How to avoid taxes on your credit card rewards
The IRS doesn’t consider rewards taxable unless exemptions are applicable, as mentioned above. But if your intention is to always avoid taxable rewards, apply for a rewards card that doesn’t give you bonuses and prizes without requiring an expense in return.
If you’ve earned rewards from your credit card spending this year, you likely won’t need to worry about reporting it come tax time. However, it may be worth reviewing the different types of bonuses you’ve earned just to be sure. If you scored a referral bonus by encouraging a friend to sign up for a card you own or received a cash bonus without a spending requirement, you might need to include that amount in your income. And if you’re a business owner hoping to deduct certain expenses, keep track of any rewards you may be using to reduce your costs.