Frequent-flier mileage awards: recent federal developments.

• Author: Johnston, Earl B.
• Position: Taxation

The IRS Position

Although airline travel frequent-flier award programs have been in existence since 1981, the Internal Revenue Service has only recently begun to address the federal income tax treatment of awards earned by employees for business travel and retained for personal use. To date, no direct authority or specific guidance has been provided concerning the procedure for valuing travel awards.

The IRS has provided guidance to the airline industry regarding the Form 1099 reporting requirements for frequent-flier mileage awards. In Private Letter Ruling 9340007 (June 29, 1993), the IRS ruled that an airline was not subject to the information reporting requirements of section 6041 with respect to its frequent-flier program. The private ruling is significant because it formally states the IRS's position on the taxability of frequent-flier miles. If the miles were earned from personal travel paid for by an individual, the free miles awarded represent only a purchase price adjustment, not taxable income. Frequent flier mileage that was earned in business-related travel and provided to the employee for personal purposes was specifically held to be a taxable fringe benefit. Because the airline lacked access to sufficient information to determine whether the recipient had earned the miles in either personal or business-related travel, however, the IRS held that the mileage value is not required to be reported under section 6041. In spite of the IRS's ruling concerning the taxable nature of business frequent-flier miles, the agency has not enforced its position because of administrative concerns and the difficulties in valuing the mileage awards.

The IRS's non-enforcement policy changed dramatically three years ago with the release of Technical Advice Memorandum 9547001 (July 11, 1995). There, the IRS ruled that a company's air travel reimbursement arrangement was a "nonaccountable" plan for purposes of section 62(c) of the Code. The TAM was issued after the company under audit refused to change its recent written policy permitting employees to retain frequent-flier mileage accrued on business travel for their personal use. The IRS --surprising even its top administrators -- ruled that the company's policy rendered both the air travel reimbursement and the frequent-flier mileage taxable.

Taxation of Expense Reimbursements

In determining adjusted gross income, a deduction from gross income is permitted under section 62(a)(2)(A) for expenses paid or incurred by a taxpayer in connection with the performance of services as an employee under an "accountable" employer reimbursement plan. Section 62(c) provides that an arrangement will be treated as an accountable reimbursement plan if:

(1) The arrangement requires the employee to substantiate his or her business expenses, and

(2) The arrangement requires the employee to return to the employer, within a reasonable period of time, any amount received in excess of the substantiated expenses.

Because employee expenses incurred under an accountable plan may be taken as a deduction from AGI, reimbursements received under an accountable plan are not required to be included in the employee's gross income, since the amounts would net to zero in calculating taxable income. Thus, amounts paid by an employer under an accountable plan are excluded from the employee's gross income, are not reported as wages on the employee's Form W-2, and are exempt from employment tax withholding. Treas. Reg. [sections] 1.62-2(c)(4).

An expense allowance arrangement will not be treated as an accountable plan if such arrangement does not require the employee to substantiate the expenses to the employer or such arrangement allows the employee the right to retain any amount (such as travel advances) in excess of the substantiated expenses.

If the employer reimbursement plan is considered nonaccountable, the federal tax treatment is much less favorable than it would be for an...