Analysis of and reflections on recent cases and rulings.

• Author: Beavers, James A.
• Position: TAX TRENDS

Gross Income

Credit card rewards for purchases of gift cards are not taxable income

The IRS could not, in opposition to its long-standing policy of treating credit card rewards for the purchase of products or services as nontaxable purchase rebates, require taxpayers to include in income large amounts of credit card rewards they received for purchasing Visa gift cards.

Background

Nadezhda and Konstantin Anikeev both held American Express Blue credit cards in 2013 and 2014. Under its Blue Cash Rewards Program, American Express would pay cardholders who made eligible purchases Blue Cash Reward Dollars. The number of Reward Dollars paid was based on a percentage (1% or 5%) of the dollar amount of the cardholder's eligible purchases, with no limit on the amount that could be awarded during a year. Eligible purchases included purchases of Visa gift cards, purchases of money orders, and purchases of reloadable debit cards and reloads of those cards.

The Anikeevs figured out a way to make the Rewards Program work for them without actually buying any goods or services. The couple would use their cards to purchase as many Visa gift cards as they could, paying service fees on the cards of 0.8% to 1.2% of the face values of the cards. They then used these gift cards to purchase money orders, for which they were charged service fees of 0.07% and 0.33% of the dollar amounts of the money orders, and deposited the money orders into their bank accounts.

At the end of each month, when they paid their American Express bills with the money they deposited (or sometimes by using reloadable debit cards or money orders purchased with their Blue cards), they were awarded the applicable percentage of their total purchases in Reward Dollars. The fees the Anikeevs were charged for their purchases of Visa cards, debit cards, and money orders were less than the total Reward Dollars they received, and the couple came out well ahead on these transactions, essentially receiving a cash payment from American Express through their aggressive use of the Rewards Program. However, at no time did American Express complain about the way the couple were gaming the program.

Pursuing their system on a grand scale, the Anikeevs used their Blue cards to make a large number of charges (mosdy to purchase Visa gift cards, but also for money order purchases and debit card reloads) that earned them Reward Dollars. They redeemed $36,200 in 2013 and $277,275 in 2014 in Reward Dollars as statement credits. On their federal income tax returns for the years, they did not include any income from the Rewards Program. While American Express did not mind the couple's gaming its program, the IRS objected mightily to their omission of the amount of their redemptions of the Reward Dollars from their income. After auditing their 2013 and 2014 returns, the Service issued the Anikeevs a notice of deficiency increasing their income for 2013 by $29,775 and for 2014 by $265,485.

The Anikeevs challenged the IRS's determination in Tax Court. In Tax Court, the IRS increased the amount of income it claimed the couple omitted to $36,200 for 2013 and $277,275 for 2014.

The parties' arguments

The IRS took the position in Tax Court that the Reward Dollars the Anikeevs redeemed were ordinary income to them when issued by American Express, arguing that the gift cards were cash equivalents because of the Anikeevs' intended use of the cards to purchase money orders. The IRS initially argued in the alternative that the couple should report as income the gains on the couple's purchases of money orders with Visa gift cards, reducing their bases in the Visa gift cards by the Reward Dollars they received on the purchases of the Visa gift cards. However, it later abandoned this argument.

The Anikeevs maintained that under the rebate rule, as set forth...