The receipt and redemption of rewards program points: Tax and reporting implications.

AuthorJones, Lynn Comer

The taxation of frequent flyer miles and other points taxpayers receive from rewards programs is a vexing problem, involving questions of timing, amount, and reporting of income. When a customer is awarded "points" that can be redeemed for merchandise, is the award itself a taxable event? Or must the points be redeemed first?

The IRS has provided little guidance, and while the Tax Court has considered the issue, its 2014 Shankar decision (1) leaves more questions than answers about the tax treatment of rewards programs. The rewards program in Shankar was a points system, under which the points earned by a program participant could be accumulated and redeemed for airfare or rewards. This article draws attention to the income tax implications of rewards programs and the Foreign Account Tax Compliance Act (FATCA) reporting requirements that could arise if rewards are made to nonresident aliens.

Background

The only IRS guidance on the treatment of frequent flyer miles and other in-kind promotional benefits is Announcement 2002-18. Announcement 2002-18 addresses only frequent flyer miles and promotional benefits that are received for business travel and used for personal travel. The IRS stated in the announcement, consistent with its practice up to that point, that it would not assert that the receipt or personal use of frequent flyer miles or other in-kind promotional benefits attributable to the taxpayer's business or official travel gives rise to income. However, it also warned that "this relief does not apply to travel or other promotional benefits that are converted to cash, to compensation that is paid in the form of travel or other promotional benefits, or in other circumstances where these benefits are used for tax avoidance purposes."

For several years after the release of Announcement 2002-18, a stealth effect ensued--the IRS did not pursue an enforcement program, and businesses did not issue information returns to customers who received points or other promotional benefits in rewards programs. However, for tax year 2009, Citibank started issuing Forms 1099 to various customers. One customer, Parimal Shankar, received a Form 1099-MISC, Miscellaneous Income, reporting the fair market value (FMV) of an airline ticket he had purchased by redeeming "thank you points" that Citibank issued as a reward for opening a bank account. Shankar did not include the $668 reported as miscellaneous income on his tax return. The Tax Court determined Citibank had appropriately issued the Form 1099-MISC and that the ticket's FMV was includible in Shankar's gross income. (2) The court relied on the accession-to-wealth principle articulated in the Supreme Court's opinion in Glenshaw Glass (3) and found that the award was similar to interest (4) given in exchange for the use (deposit) of Shankar's money.

Although Citibank issued Shankar a Form 1099-MISC, given the court's interpretation that the award was "interest" because it was a premium for opening a bank account, it seems a Form 1099-INT, Interest Income, would have been more appropriate. However, in 2009, Citibank also issued Form 1099-MISC to customers for frequent flyer miles awarded when the customers opened accounts. (5) (The de minimis reporting requirements for Forms 1099-MISC and 1099-INT are $600 and $10, respectively.) To the extent interest is paid to a nonresident alien, the payer must file Form 1042-S, Foreign Person's U.S. Source Income Subject to Withholding. (6)

Shankar's implications

Citibank's proactivity in issuing the Forms 1099 could have opened a floodgate of IRS enforcement against companies for failure to file and furnish the information returns. Citibank issued the Forms 1099 shortly after the 2008 financial crisis, perhaps in an attempt to avoid IRS penalties. The current penalty for failing to file an...

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