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Do You Have to Pay Taxes on Credit Card Rewards?

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All year round, there is an endless stream of sign-up bonuses for bank accounts and credit cards. Anyone who has ever received a bonus for opening a new checking or savings account will know that these bonuses must be reported when tax time arrives because the bank will send a Form 1099 for the bonus amount. But what about those frequent flyer miles and cash back bonuses that you receive when you sign up for a new credit card or spend with a credit card? Do you know whether you have to pay taxes on credit card rewards?

It makes sense to classify miles, points and cash back as “free gifts” — items that you’d never think that you would have to pay taxes on. However, you might have to pay taxes on these rewards, and it all depends on how you receive them.

“If you receive noncash gifts or services for making deposits or for opening an account in a savings institution, you may have to report the value as interest,” the IRS says in Publication 550 Investment Income and Expenses. “For deposits of less than $5,000, gifts or services valued at more than $10 must be reported as interest. For deposits of $5,000 or more, gifts or services valued at more than $20 must be reported as interest.” The cost to the bank is the value that must be reported.

In 2012, the LA Times reported on a case where a Citibank customer received a tax form because he received 25,000 American Airlines miles for signing up for a checking and savings account package. He was surprised when he was required to pay taxes on $625 worth of miles (each mile was valued at 2.5 cents). Citi reiterated that it was following the rules and that the customer had to pay taxes on the miles.

How to Know If You Owe

With deposit accounts, it’s relatively easy to know whether or not you’ll get a tax form for your account bonuses because the bank states it in the fine print, often at the bottom of promotional bank deal webpages or letters. An example would be a bank promotion in which a customer who opens a new checking account and posts a direct deposit will collect a $100 bonus. Such incentives for opening a new brokerage account or retirement accounts will also be taxed.

For credit cards, however, no such fine print exists. You are not making a deposit to earn the credit card bonus. Rather, you’re most likely required to spend a certain amount on purchases during a specified period of time to earn the bonus.

For instance, you may be required to spend $500 on card purchases in three months to earn 20,000 bonus miles.

The IRS offers no official guidance on such credit card sign-up bonuses or the regular rewards that are earned as a result of card spending. The lack of guidance contributes to the confusion when it comes time to prepare your tax return. But, there is a general rule adopted by the tax-preparation community.

“For most of these rewards that are given to consumers, the IRS treats them as discounts rather than income,” says tax preperation service TurboTax. “If you think about it, it’s not as if any of these companies are offering you cash for nothing; more often than not it’s used as incentive for you to purchase something. And since a discount isn’t taxable, there’s no need to keep track of all your cash back rewards to prepare your tax return.”

To the many consumers who tend to accumulate hundreds, or even thousands, of dollars’ worth of credit card rewards on an annual basis, this news could bring a sigh of relief.

Image: iStockphoto

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  • http://www.joetaxpayer.com JoeTaxpayer

    Simon, I’ve always viewed it that a ‘signup bonus’ has the potential to be taxed, as there’s no rebate aspect involved. Any spending rewards such as 2% back on credit cards should be tax free. Your explanation is in line with my understanding.

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