The taxing part about 'free' gifts; giving away gifts or cash to customers is a valuable marketing tactic, but it also involves certain disclosure and reporting requirements. Here's what the Internal Revenue Code has to say about those things that we bestow without charge.

• Author: McCollough, Jennifer
• Position: Compliance

Editor's Note: In the our last issue, we looked at cash, gifts and other freebies for hank customers and reviewed the disclosure and reporting requirements that these practices trigger under the Truth in Savings Act and Regulation Q. We continue the discussion by examining the requirements of the Internal Revenue Code.

Before we discuss the tax rules, keep in mind that the IRS figures nothing in life is free--or more precisely, "tax free." Specifically, customers who receive a bonus or gift might need to pay income taxes on the amounts received, which may be considered taxable interest or miscellaneous income. Financial institutions that pay bonuses are probably required to report them under Internal Revenue Code (IRC) Section 6041 or Section 6049.

To better understand when and what to report, you must first understand the definition of "interest." For federal income tax purposes, interest is a dollar amount paid in compensation for the use of money. More precisely, for information reporting purposes under IRC [section] 6049 (the information reporting provisions for Form 1099-INT), interest is defined as amounts paid in respect of deposits or investment certificates. All interest totaling $10 or more per year per customer must be reported to both the IRS and the customer.

In addition to paying cash interest, a financial institution may provide a "gift" (also referred to as a premium or a bonus) as an inducement to a customer either to open a deposit account or to add to an existing account. Such gifts are also considered interest, the fair market value of which may need to be reported. The IRS does consider certain de minimis or very small noncash gifts to be free of tax and not subject to reporting on Form 1099-INT, under Revenue Procedure 2000-30. Specifically, if a noncash premium costs the financial institution less than $10 and the premium is given in connection with a deposit of less than $5,000 (or less than $20 on deposits of $5,000 or more), reporting on Form 1099-INT is not required and the customer would not incur taxable income. Note that the de minimis rule applies only when the bonus or premium is not cash.

To determine the value of a noncash premium for reporting purposes, the financial institution must determine the fair market value of the property. For example, if a financial institution pays $11 for each George Foreman grill it gives away, it may report the $11 it paid for the item on the Form 1099-INT as the fair market value even though the grill may retail for $14.95.

And remember, even though the dollar amount of interest paid to a customer may not be reportable when viewed by itself and the value of a noncash premium may not be reportable when viewed by itself, the two together may exceed the threshold. If, for...