Paul L. Caron

Tuesday, January 24, 2012

Why Does Citibank, But Not the IRS, Treat Frequent Flyer Miles as Taxable Income?

CitibankLos Angeles Times, Citibank Deems Frequent-Flier Miles Taxable, but Does the IRS?, by David Lazarus:

Frequent-flier miles clearly have value — why else would people want them? But do they also represent taxable income? Citibank seems to think so. It's sending tax forms to people who received thousands of miles as a reward for opening a checking or savings account. Those forms value each mile at about 2.5 cents and list the total dollar amount as miscellaneous income.

This is news to tax pros. "I've been practicing for 25 years and I've never had an instance where miles have been treated as taxable," said Gregg Wind, a West Los Angeles certified public accountant. But he said that because Citi is reporting this as people's income to the Internal Revenue Service, customers may be on the hook for paying the taxes. "Otherwise," Wind said, "your chances of being audited could go up." ...

Larry Fechter, 66, of Palm Springs was among numerous Citi customers who received a Form 1099 in recent days. He opened a checking and a savings account with the bank last summer after being promised 25,000 American Airlines miles. ... Fechter said it was a big surprise to get the form in the mail informing him that he has to pay taxes on $645 worth of miles. If he were in the 28% tax bracket, that would mean a payment of $180.60 owed to Uncle Sam. ...

In 2002, the IRS issued a policy brief [Announcement 2002-18,] noting that because there are "numerous technical and administrative issues" relating to miles, such as how they're valued and used, the agency "has not pursued a tax enforcement program with respect to promotional benefits such as frequent-flier miles." "Consistent with prior practice," it said, "the IRS will not assert that any taxpayer has understated his federal tax liability by reason of the receipt or personal use of frequent-flier miles or other in-kind promotional benefits attributable to the taxpayer's business or official travel." ...

Catherine Pulley, a Citi spokeswoman, cited the 2012 instructions for Form 1099-MISC, which state that income tax must be paid if at least $600 in "prizes and awards" is received.

For more, see The Tax Treatment of Frequent Flyer Miles: An Update.  (Hat Tip: Ann Murphy.)

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Essentially, if you deducted the overpayment of state taxes and if it actually reduced your 2010 federal income tax liability, the IRS wants to get its money back.

If you didn't pay AMT for 2010, this website explains the situation:

If you did pay AMT, this can be a problem to figure out. If your AMT liability was more than 30% of the refund amount, you probably have a fully non-taxable refund because the original payment of that amount by you to the state didn't actually reduce your 2010 federal tax liability.

Posted by: AMTbuff | Jan 25, 2012 4:57:46 PM

On a not unrelated topic, something that completely and totally mystifies me...

Let's work with small, round numbers on this, because it is easier for me to wrap my brain around small, round numbers. Let's say I earn such that my adjusted gross income is $10,000 in 2010, and my income tax computed out at $1,000 but, since Ihad $100 withheld every month, I had paid $1,200 in income taxes, therefore, I had a refund of $200. So, I get a check from the Fairy Godmother of Taxes for the sum of $200. Now it is a REFUND of taxes I overpaid in 2010, from money EARNED in 2010, and considered in the total of the money I earned when calculating my 2010 taxes. So why, (and this is what mystifies me and FROSTS MY BUNS) do I have to claim it as part of my 2011 (and just for emphasis, TWO-THOUSAND-AND-ELEVEN) income? It was EARNED and REPORTED ALREADY in 2010? And TAXED! Why!?!? And just to make sure I do, Californiajust sent me a 1099 with their #*$&%$&# tax refundfrom 2010....

Posted by: Lee | Jan 25, 2012 10:03:51 AM

The Citigroup situation is an unusual situation. Miles awarded when a customer books a non-business flight represent a reduction in the cost of the ticket, not gross income.

Posted by: Elmer Stoup | Jan 25, 2012 7:04:34 AM

This is more a valuation issue than anything else. It is laughable that they value these miles/points at 2.5 cents on the dollar when in many cases they convert at less than a penny each. I wonder if they are also taking a deduction for that arguably inflated value.

Posted by: Jerome | Jan 24, 2012 5:35:08 PM

Citicorp is right, giving a toaster, $100, or frequent flier mile points to new customers is an item of gross income. This is distinguishable from ordinary air travel which may be personal and non-deductible.

The Airline Transport Association at the inception of the frequent flier programs had lobbied against it on the basis of administrative difficulties, taxability vs granting of discounts, and tax benefit doctrine, (no tax benefit-on paying airfare- no income on mileage points.

Posted by: Del Dibig | Jan 24, 2012 1:01:56 PM