Note: I am not a tax professional.
I was recently reading a post on the Tax Implications of Reselling and MS by Noah at Money Metagame, and at first, felt the need to comment, but as I found myself writing…and writing….and writing, I figured it may be better to just write a post.
Let’s take down the easy answer first:
Miles and Points
Generally speaking, miles and points as earned by travel (yes, open ended term), are generally viewed as “Rebates,” and are not in fact taxable. I agree with Noah, this is a gray area, however, I look to people smarter than me, to try to do some interpretation. In this case, to Gary Leff who writes View from the Wing, who has written a fair amount about the taxation of miles. However, there is a caveat, as noted in the second link, and if I may remind you of Citibank sending out 1099-MISC forms for those who received bonus miles or points for opening up a Citibank Checking Account. Now, based on my research, it seems like you can avoid being taxed on the Citibank Checking Account Bonus by not redeeming the Thank You Points (for example), in the same calendar year as they are earned, but, I haven’t tried that myself.
Cashback
This is where my opinion diverges greatly from Noah. For example, in his examples toward the end of the post, he cites:
Second example: I use a credit card that earns 6% cash back at a grocery store to buy a $500 Visa gift card. The cost is $505.95 because of fees and the credit card earnings will be $30.36 in cash back. For simplicity, let’s say we deposit the $500 directly into a checking account. The profit calculation for this example is sell price ($500) minus buy price ($505.95 minus the $30.36 “rebate” or $475.59) for a profit of $24.41. As far as the IRS is concerned, you made $24.41 in earned income on this particular transaction and are obligated to report it as miscellaneous income and pay taxes on it. – Money Metagame – Emphasis mine.
I believe this is factually wrong, based on a ruling I was able to dig-up from the IRS. The document really speaks to whether a taxpayer can direct cashback to charity and take a deduction. That said, the document states the following as fact:
Taxpayers are individuals who will acquire credit cards issued by a bank through an arrangement promoted by Company. Taxpayers will make purchases with the credit cards and, as a result of those purchases, will be entitled to receive rebates. The rebates are based on a percentage of Taxpayers’ credit card purchases (usually 1%) and reduced by fees charged by Company (e.g., administrative and marketing). The percentage of Taxpayers’ credit card purchases, less fees, equals the amount of the rebate to which Taxpayers are entitled ($X). – Emphasis Mine.
It goes on to offer the Law and Analysis:
Section 61 provides that gross income means all income from whatever source derived. A rebate received by a buyer from the party to whom the buyer directly or indirectly paid the purchase price for an item is an adjustment in purchase price, not an accession to wealth, and is not includible in the buyer’s gross income. See Rev. Rul. 76-96, 1976-1 C.B. 23, as modified by Rev. Rul. 2005-28, 2005-1 C.B. 997. – Emphasis Mine.
The conclusions reached are:
(1) The portion of the credit card purchases that Taxpayers can either receive back in cash or request Company to pay to a charity does not constitute gross income to Taxpayers under § 61. – Emphasis Mine.
Wrapping Up
Again, I’m not a tax professional, nor an accountant, but as I read this ruling, it seems to me that cashback is in fact viewed as a “Rebate” and not as earned income. I guess it brings me back to that old saying, the only guaranteed things in life are death and taxes.
What is your read? Do you report your miles, points, and cashback on your taxes?
Thank you for your post and taking your time to provide this analysis. It seems to be that if you earn cash back, miles, points, etc on credit cards, they do not deem that to be gross income. However, cash earned for opening up bank accounts tends to be viewed as gross income. At least that’s been my view on this for a while. I am still surprised that $ sign up bonuses on credit cards are not taxed, but so be it — we may as well enjoy them.
Cheers,
PedroNY
Yes, and I believe that is totally logical for two reasons. #1 You didn’t purchase anything from the bank to be “rebated.” #2 Many of them spell out in their terms that the bank bonus will be reported as interest on a 1099-INT.
I think the primary distinction between bank bonuses and credit card bonuses is the requirement of a “purchase”. With a CC, they can simply look at the signup bonus as a rebate on the required purchases and don’t have to worry about sending out a 1099.
Bank bonuses on the other hand typically don’t require purchases (some require debit card purchases), so there is nothing to rebate against and therefore they just consider it taxable income and send a 1099.
To you point, Alaska Airlines credit card does not require any purchase for the bonus to post. So I don’t know how that is still deemed a rebate. Just some food for thought. 🙂
Cheers,
PedroNY
Yeah, lucky for us the IRS doesn’t consider those 25k points to be worth anything! If you get the $100 statement credit though, that does require $1,000 in purchases and fits under the rebate definition. I hope we can ride the miles/points train for a long time before the IRS changes up their rules to value them as cash in some way. That will be a bad day if it ever comes to fruition.
Best,
Noah
Very good info you just put together, thank you.
What about cash back from portals? Does this apply to reselling as well? Say you buy a $300 iPad, Sell it for $290, but get $60 cash back for a $50 “profit”. Can you say you sold the iPad for a $10 loss?
If the portal is offering cash (not points or miles), then you should reduce your purchase price by that amount. Then once you sell the calculation is Sell Price – Cost Basis or $290 – $240 for a profit of $50 as you mentioned. Consult a tax professional, but I would report $50 in income on my taxes.
We agree that all cash back earned from credit cards (and more) are rebates. Any rebates earned are not taxable by themselves because they are simply reductions on the purchase price. This is what all of your examples refer to and there seems to be a consensus on the fact. I never said otherwise in my post.
Our point of contention is turning what you bought back into cash. That is what triggers a possible taxable event much like a sale of goods.
Once you turn your purchase back into cash, you have to determine whether or not you made any income. To do that you simply calculate:
Sell Price – Cost Basis or
Sell Price – (Buy Price – Rebates) = Profit
In my example you quoted, the calculation is:
$500 – ($505.95 – $30.36) = $24.41
That $24.41 is pure profit and therefore taxable.
To repeat, I never stated cash back by itself is taxable and everyone seems to agree that they are rebates. It’s the cashing out of your purchased product (a VGC in this case) that triggers a possible taxable event.
@Noah, We can agree to disagree, cashback is a rebate, plain and simple. Going on your logic, if you purchased a product for less than a rebate available was (and that happens occasionally with Staples), then would you report that on your taxes? Plus, there’s no real way to track it anyway, I mean, to report that $24.41 as “profit” on your taxes would only invite an audit because you can’t associate it with a 1099, 1120, W2, or any form that shows it as earned.
We agree cashback is a rebate, there’s no debate there. You’re choosing to ignore what a rebate actually is, which is a reduction on the purchase price. Your own example spelled this out:
“A rebate received by a buyer from the party to whom the buyer directly or indirectly paid the purchase price for an item is an adjustment in purchase price, not an accession to wealth, and is not includible in the buyer’s gross income”
Anytime cash money goes into your pocket or account, you need you determine whether or not that was income for tax purposes. You can reduce the amount by your cost basis on the transaction (whatever you paid minus any rebates), but whatever is left over is income. This applies for more than free after rebate items, selling concert tickets, selling merchandise, cashing out VGCs, and ANYTHING else that moves cash into your hands. The IRS doesn’t care HOW you accumulate money, IF you’re making money at all, it’s taxable.
Do most people report income when they resell a concert ticket, find $10 on the ground, or watch their friend’s dog for a weekend for $50? No. That doesn’t change the rules when it comes to taxable income and under an audit, you will have to pay up for everything they find. The risk/reward choice of claiming it all is yours, but claiming your profit is exempt in some way because you channeled it though credit cards doesn’t change the fact that’s it’s profit and therefore taxable income.
Btw, the 1099-MISC is the form you’re looking for to report miscellaneous income like the type we’re talking about.
I disagree with your logic on that one and agree with Noah. That $500 Visa gift card is still your $500 cash sitting in an FDIC insured bank. The bank just places artificial restrictions on you that you can’t use the PIN number for direct ATM access and limits you to $500 on the card — probably because it is lower than the anti-money laundering thresholds and it would be completely impractical to require everyone to know who they are giving every gift card to in advance along with their address, DOB, and SSN!
If you disagree with that, at worst it is still considered a cash equivalent, and the IRS treats cash and cash equivalents the same for tax purposes. Otherwise millionaires would empty their bank accounts into Visa gift cards to distribute to their heirs shortly before their death and avoid inheritance taxes. $4.95 per $500 is slightly less than 1%, which would be a heck of a lot cheaper than the going rate!
I think you’re pretty much just making a cash transfer from one account into another account. Or cashing out cash, if you will. Buying a $500 visa gift card does not make your cash turn into non-cash. Otherwise, another great loophole would be that every business could spend all their profits buying $500 gift cards at the end of every tax year and only pay a 1% fee instead of income tax!
To clarify, since I am swinging on the porch with my five-month-old and writing this reply from my iPhone, I disagreed with Noah saying that $24.41 was taxable income. Not agreed with him. Cheers! 🙂
Excellent find.
The Citibank one I think was deemed to be incorrect by the IRS. I handle the tax area and we have had similar conversations in our bank regarding the reward offers. The bonuses for checking accounts always receive a 1099. The bank I work for has credit card products and they are considering the 1099’s for the credit card rebates as well. Still in talks with the legal folks on how this should be handled. I don’t intend getting that product anytime soon!!
@Raj, question, since you work in the tax area, what is the benefit to the bank to issue 1099’s? Do they get some sort of tax deduction benefit? I have to believe that the banks are getting some sort of benefit, because otherwise, they’d be putting undue burden on their customers for no gain…
It is more of an IRS requirement. The banks do not get any benefit. I should have clarified further. It is mandatory to issue 1099’s if you deposit the cash back into you checking account. Taking that as a statement credit does no harm. The bonuses over $10 always get a 1099-int.
Leaving the legalese aside for a second, does anyone actually report these earnings to the IRS? For me, if the transaction generates a 1099 I report it. If not, let it ride. Not arguing ethics/morals here but just wondering if anyone actually spends the time to calculate all this?
@Raj “taking statement credit does no harm”. If you could elaborate on how that works with IRS, would be appreciated pls. Thank you
With IRS staffing being reduced further this year, any major flag raised by a tax payer will get investigated thoroughly by a team of 3 agents. Don’t raise “major flags”.
Can you site any sources to support your claim that tax issues are now going to be scrutinized by a 3 agent team due to budget cuts? With such a staffing cut, agents’ workloads are going to be dramatically increased, which logically means less time spent on each case — not more time spent on each case and by more agents.
Cite not site — sorry, stupid autocorrect. LOL
Thanks for the post!
I recently entered the MS game, and have been very worried about the tax implications.
You have put some worries to rest.
I really hope your analysis is correct, but there seems to be so much grey area in the definition of a “rebate”.
@Gabe – Thanks for your comment! There is a lot of gray area, and the fact is, congress could change the game with legislation at any time. But, I stick to my analysis at the present.