The Internal Revenue Service (IRS) has spoken up very few times regarding the tricky issue of credit card rewards. These rewards represent money or free travel that you didn’t have before, right? It’s reasonable to assume rewards must be taxable.
But generally, you do not have to perform a year-end tally of those rewards or figure out where they go on your tax return. Some exceptions exist, however, and your credit card issuer might use ominous language on your contract indicating your responsibility.
What the IRS Has To Say About It
The IRS announced in 2002:
"Consistent with prior practice, the IRS will not assert that any taxpayer has understated his federal tax liability by reason of the receipt or personal use of frequent flyer miles or other in-kind promotional benefits attributable to the taxpayer's business or official travel."
So, this covers miles and “in-kind” benefits, which roughly translates to “something similar.” The IRS takes the position that this includes cash back, because you’re effectively getting a rebate on the money you already spent. According to the IRS, you don’t have to pay taxes on cash-back rewards any more than you would have to pay on that $50 rebate you got when you bought an appliance.
Rewards are different from income because you didn’t earn them through work or business, or receive them in exchange for making an investment. You had to spend something to get them, and what you received was less than what you spent.
An Exception to the Rule
You might be on the hook for taxes if you don’t make a literal transaction, such as if a card issuer offers you a referral bonus. Or, say, if you got $700 to open an account and that money is credited to your account before you ever use the card. That situation is more likely with bank accounts than credit cards. Either way, must these gifts be reported as income?
“It depends,” said Chip Capelli, an accountant in Provincetown, Massachusetts. “Technically, this is interest paid to a customer, so it should be reported on Form 1099-INT to the customer. I’ve seen it happen, and I’ve seen it not happen.”
Capelli said Form 1099-INT is required when interest earned exceeds $10 in a year. Even if you don’t receive a Form 1099-INT, you’re required to report all interest income on your federal income tax return.
Depending on the bank and how it classifies your bonus, there’s also a chance you will receive a 1099-MISC. That form is required for many types of miscellaneous income, such as prizes or awards worth at least $600 and royalties worth at least $10. Sometimes a lender will send out the form, even if the bonus doesn't technically trigger the need for a 1099-MISC form. In fact, some card issuers include warnings in their contracts that this might happen.
What About Business Purchases?
The same rule generally applies to business credit cards, but there’s something else to keep in mind with business cards and taxes.
Maybe you have a consulting business, and you must travel to another city to perform services for a client. You spend $750 in travel costs, and you charge the expense to your business credit card. The credit card company says, “Great! Thanks for using our services. Here’s 2% cash back.”
Your business can go ahead and pocket that $15 without reporting it as income, just as you could for a personal cash-back credit card reward. But you can’t also deduct the $750 cost of the trip as a business expense on your Schedule C. You can only claim a business deduction for $735, because that’s really all you spent after getting that 2% cash back.
“If you have a business credit card, a good rule of thumb is that any rebates on those purchases are subtracted from the costs, reducing the amount that you can claim as an expense,” Capelli said.
On the bright side, there’s that 2002 memo from the IRS. It says you don’t have to claim as income “the receipt or personal use of frequent flyer miles or other in-kind promotional benefits attributable to the taxpayer's business or official travel." In other words, you can personally use rewards accrued on business accounts without paying taxes on them, but you would still have to subtract the amount from any tax deduction you claim for your business.
Can You Give These Rewards Away?
Maybe you don’t really need that cash back and you’re the altruistic sort. Maybe you’d rather make them a gift to a charity. If you do that, can you claim a tax deduction for it?
No, said Capelli. “The IRS recognizes rewards points and miles as a gift or a reward from the corporation to the individual. Therefore, points and frequent flyer miles donated to charity are not considered tax-deductible. Another way to look at it is that the deductible amount is the lesser of the fair market value of the item basis, because you didn’t purchase them. Therefore, this is not a legitimate deduction.”
So, taxpayers beware. Some credit card companies actually give you the option to send the money to a charity rather than have it applied to your card balance, but the IRS isn’t going to let you write the gift off.
Stay on the Safe Side
Check with a tax professional if you think you might owe taxes on any bank account or credit card bonuses you receive—especially if you get any 1099 forms from the bank or credit card issuer. Sometimes it can be confusing and hard to determine whether you owe taxes or not, but an accounting professional can tell you for sure.