Smart SpendingSmart Spending

Do you have to pay taxes on credit card rewards?

So you've accumulated frequent flyer miles and cash-back bonuses using your credit card - but do you have to pay taxes on them?

By Credit.com Jul 19, 2013 5:31PM

This post comes from Simon Zhen at partner site Credit.com.


MSN Money partnerAll year 'round, there is an endless stream of sign-up bonuses for bank accounts and credit cards. Anyone who has ever received a bonus for opening a new checking or savings account will know that these bonuses must be reported when tax time arrives because the bank will send a Form 1099 for the bonus amount.

Image: Man paying with credit card © UpperCut Images/UpperCut Images/Getty ImagesBut what about those frequent flyer miles and cash back bonuses that you receive when you sign up for a new credit card or spend with a credit card? Do you know whether you have to pay taxes on credit card rewards?

It makes sense to classify miles, points and cash back as "free gifts" -- items that you’d never think you'd have to pay taxes on. However, you might indeed be required to pay taxes on these rewards, and it all depends on how you receive them.

"If you receive non-cash gifts or services for making deposits or for opening an account in a savings institution, you may have to report the value as interest," the IRS says in Publication 550 Investment Income and Expenses. "For deposits of less than $5,000, gifts or services valued at more than $10 must be reported as interest. For deposits of $5,000 or more, gifts or services valued at more than $20 must be reported as interest." The cost to the bank is the value that must be reported.

In 2012, the Los Angeles Times reported on a case where a Citibank customer received a tax form because he earned 25,000 American Airlines miles for signing up for a checking and savings account package. He was surprised when he was required to pay taxes on $625 worth of miles (each mile was valued at 2.5 cents). Citi reiterated that it was following the rules and that the customer had to pay taxes on the miles.

How to Know If You Owe
With deposit accounts, it’s relatively easy to know whether or not you’ll get a tax form for your account bonuses because the bank states it in the fine print, often at the bottom of promotional bank deal webpages or letters. An example would be a bank promotion in which a customer who opens a new checking account and posts a direct deposit will collect a $100 bonus. Such incentives for opening a new brokerage account or retirement accounts will also be taxed.

For credit cards, however, no such fine print exists. You are not making a deposit to earn the credit card bonus. Rather, you’re most likely required to spend a certain amount on purchases during a specified period of time to earn the bonus.

For instance, you may be required to spend $500 on card purchases in three months to earn 20,000 bonus miles.

The IRS offers no official guidance on such credit card sign-up bonuses or the regular rewards that are earned as a result of card spending. The lack of guidance contributes to the confusion when it comes time to prepare your tax return. But, there is a general rule adopted by the tax-preparation community.


"For most of these rewards that are given to consumers, the IRS treats them as discounts rather than income," says tax preparation service TurboTax. "If you think about it, it’s not as if any of these companies are offering you cash for nothing; more often than not it’s used as incentive for you to purchase something. And since a discount isn’t taxable, there’s no need to keep track of all your cash back rewards to prepare your tax return."
To the many consumers who accumulate hundreds, or even thousands of dollars' worth of credit card rewards on an annual basis, this news could bring a sigh of relief.

More from Credit.com:

DATA PROVIDERS

Copyright © 2014 Microsoft. All rights reserved.

Fundamental company data and historical chart data provided by Morningstar Inc. Real-time index quotes and delayed quotes supplied by Morningstar Inc. Quotes delayed by up to 15 minutes, except where indicated otherwise. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by Morningstar Inc.

ABOUT SMART SPENDING

Smart Spending brings you the best money-saving tips from MSN Money and the rest of the Web. Join the conversation on Facebook and follow us on Twitter.

VIDEO ON MSN MONEY

TOOLS

More