I know I’m not covering new territory here, but January is a little depressing – right? I mean, it’s cold, the holidays are over, your football team has probably already been eliminated from Super Bowl contention (ok – not you, Patriots fans), and did I mention that it’s cold?
It’s also the time those credit card bills start to show up from all that December spending. Maybe it’s time to redeem those credit card points or miles you’ve been saving up and jump on a plane headed someplace warm. How about Miami, or maybe Maui? Sounds exciting, right?!
Well, before you start clearing your calendar, think about this – redeeming those points or claiming your rewards may be a taxable event. Yes, I know it’s surprising, but the IRS looks everywhere when it comes to finding opportunities to collect revenue.
Ok, now that I’ve interrupted your daydreams of sipping a tropical drink on a beach somewhere, let’s consider several issues and strategies that can save you big time:
- Good news first – you will most likely not be taxed when you redeem your credit card rewards/points. Why? Because most rewards/points are “earned” through your use of the card. Most of us accrue our rewards/points/miles, whatever, as we charge goods and services to our cards. As such, the IRS considers the redemption of these rewards a “discount” or a “rebate” on those purchases, instead of income to be taxed – how altruistic of them!
Some common examples of credit card rewards that do not need to be reported as income are cash-back programs, travel miles bonuses, accumulated points towards future purchases, and credit card sign-up bonuses that require a financial transaction, such as making a purchase, to be realized.
- Now for the bad news – that “free” bonus or reward that you got just for signing up probably isn’t tax free. Why? Because unlike with rewards that you earn as you make purchases, when you get a bonus just for signing up, or switching cards, or opening a bank account, that bonus can’t be considered as a “discount” or a “rebate” of anything. You didn’t spend anything to get it, so it’s considered taxable income. Please also keep in mind that the sign-up bonus doesn’t have to be in cash in order to be taxable.
Anything you receive that isn’t tied to actual use of the card, whether it’s cash, airline miles, tangible goods, Super Bowl tickets, or anything else, is going to be considered taxable income. And because banks and credit card companies don’t like running afoul of the IRS, you can count on receiving a 1099-MISC tax form in the mail for the value of bonus. If you don’t like running afoul of the IRS, you will in turn report that income when you file your personal tax return.
- What about rewards on my business purchases? Rewards earned on business purchases are a bit different. Let’s say you use a credit/debit card for $10,000 worth of business expenses during the year, and those purchases earn you $200 cash back from your credit card company. While that $200 isn’t considered income per se, it does reduce the amount of the deduction you can take for those expenses – by $200 from $10,000 to $9,800. Thus, the IRS may consider that taxable income and credit card companies are apt to send you a 1099 for that rebate.
- Be strategic in the use of your miles. Since your miles aren’t taxable income, and personal travel isn’t tax deductible, the most prudent and wise strategy is to ONLY redeem miles or points for ‘personal travel’. As such, you take a tax deduction for business travel while earning miles you redeem ‘tax-free’!! Frankly, it makes that tropical drink taste a little more sweet when you know you didn’t have to share the trip with Uncle Sam.
Bottom line, if you are simply redeeming miles or points, you aren’t going to be taxed on the value and should be skipping to the ticket counter. However, with that being said, don’t ignore a 1099-MISC, if your credit card company or bank sends you one in the mail.
If you don’t understand why you received the 1099, call your credit card company. If it turns out to be legit, then report the income and pay the taxes. Following this procedure will help you prevent a small annoyance (potentially paying taxes on a few hundred extra dollars in income) into a much bigger problem (an omission that you have to explain later to the IRS during audit).
Mark J. Kohler is a CPA, Attorney, Radio Show host and author of the new book “The Business Owner’s Guide to Financial Freedom- What Wall Street Isn’t Telling You”, and “The Tax and Legal Playbook- Game Changing Solutions For Your Small Business Questions”. He is also a partner at the law firm Kyler Kohler Ostermiller & Sorensen, LLP and the accounting firm K&E CPAs, LLP. For more information visit him at www.markjkohler.com. [Jarom Bergeson assisted in the authoring of this article. Jarom is an attorney in the Utah office of KKOS Lawyers]