Since when are frequent flier miles taxable?
Citibank sent out 1099s this year, counting miles awarded in a promotion as income. That judgment may be right, but here's how to deal with the inflated value Citi put on the miles.
This post is by William Baldwin at Forbes.com.
The longstanding American tradition of not declaring miles as income is now at risk.
The big bank has been mailing out 1099 forms to depositors reporting, as income, the mileage awards they got for opening Citi accounts.
Worse, the bank evidently came up with the lavish valuation of 2.5 cents a mile.
Ridiculous, says Dominic Daher, co-author of a West hornbook on tax law and adjunct professor of taxation at the University of San Francisco; the fair market value of miles is more like a penny each. (Post continues below video.)
The story first surfaced in The Los Angeles Times. U.S. Sen. Sherrod Brown, D-Ohio, jumped on it, writing to the federally bailed out bank demanding that it back off. So far, the bank has not responded to either the senator’s letter or a query from Forbes.
Apart from the price it put on the miles, Citibank may well have been within its rights. There’s a specific tax law forbidding the IRS to tax miles handed out the usual way, as a reward for travel. But miles as an inducement for moving assets into a bank are something else. They look like interest.
Someone who gets 50,000 miles for opening an account and then gets a 1099 for $1,250 is likely to be displeased. The tax (state and federal) on that interest could easily be $500, more than the miles are worth if they are hemmed in by blackout dates and other restrictions.
What is a depositor to do? Report the inflated income and pay tax on it like a sap? Omit the income and risk an audit?
A Hobson’s choice. “This is precisely the problem that Citibank created with this debacle,” says Daher.
Any mismatch between what’s on your 1040 and what’s on a 1099 sent to the government is likely to precipitate a nasty letter from the IRS, if not a full-blown audit.
Don’t just ignore an inflated 1099, Daher urges. Call the offending bank and ask for a corrected 1099. If that doesn’t get you anywhere (it probably won’t), you should report the gross amount on your 1040 and then claim an adjustment bringing the income down to a fair amount, he says.
This adjustment could go on line 21 of the front of your return or on Schedule B, where you’d put other adjustments to interest amounts (such as amortization on a bond you bought for more than its redemption value).
It’s unclear if other banks and brokers are going to follow Citi’s lead in ratting out customers who got airline miles. Daher notes that, several years ago, a mutual fund company asked the IRS for advice on how to handle miles it gave to a new customer.
The company was instructed to treat the value of the miles as a reduction in the cost of fund shares, potentially increasing the taxable gain when the customer cashed in.
One Fidelity Investments customer we know got 50,000 Delta miles in 2010 for adding assets and did not get a 1099 on it. Fidelity declines to comment on its current policies.
If you are fretful, review this Q&A.
Q. I got 50,000 miles for opening a credit card account. Are they taxable?
No. Credit card freebies are tax-free because they are a reduction in the cost of the goods bought with the card. If a sofa is advertised at $900 and you get a $50 rebate, you don’t have taxable income. You have simply bought a sofa for $850.
Q. What about the 2% cash back I get on my credit card?
Not taxable, if the charges were for personal expenses.
Q. I charged $10,000 of business expenses on my card and then got back $200. Is the $200 taxable?
Yes. You should either deduct only $9,800 as business expenses or else deduct $10,000 and then report $200 as miscellaneous income.
Q. What if I don’t account for that $200? Will I get caught?
Q. I earned 50,000 airline miles by taking a lot of personal trips. Is the value taxable?
No, and it shouldn’t be. It’s a reduction in the cost of the original flights. It’s like the $50 rebate on a sofa.
Q. I earned miles taking business trips that my company paid for. Are they taxable?
No, but they should be. The airline was engaging in commercial bribery. Bribes are taxable.
Q. So why aren’t miles earned on business trips taxable?
Because Congress, fearing an armed revolt, directed the IRS to keep its hands off them.
Q. If I want to be honest about those credit card rebates I earned on deductible business expenses, I will have to file three 1040X amended returns, plus state and city returns. Will I be eligible for a frequent filer discount?
The IRS has not issued guidance on this point.
More from Forbes.com and MSN Money:
VIDEO ON MSN MONEY
If this is the case, then CITI should have to pay each person 2.5 per mile they wish to cash in.
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