Frequent Flyer Miles Tax Issues

Citibank has sent a number of customers 1099 tax forms to report their frequent flyer miles earned when they opened a checking or savings account last year.  (Citibank Article.)  The terms and conditions of the offer were disclosed in promotional materials, but the practice has caused confusion and concern for many who must now report their frequent flyer miles (and possibly other credit card rewards for that matter) as income.

The bank claims that the issue is whether credit card rewards are rebates on money spent under the relevant provisions of the tax code.  When a customer of a bank opens a checking or savings account, the customer did not spend money.   As such, the reward for doing this cannot be considered a rebate.   Smaller gifts aren't reported by banks since their value is negligible, but pricey gifts can add up.

Regardless of whether this is a legitimate claim, the benefit to Citibank in reporting the miles is clear.  It can report the retail amount of the miles (more than the amount Citibank pays), thereby gaining a write-off where the customers incur the liability.

Citibank calculates the airline miles value at 2.5 cents a mile, supposedly based on an average price of $625 for a domestic coach ticket (25,000 miles).  However, these "average" ticket prices may not be accurate and instead are much higher than lowest available prices.   This is because the “average” includes expensive business tickets as well as cheap leisure tickets.  Also, value based on prices for purchased tickets does not reflect the lesser value of seats allocated to frequent flyer awards.  (Orlando Sentinel article.)

This leaves consumers with $625 in tax liability for opening a checking account.  Depending on which tax bracket the consumer is in, this could mean up to $218 in taxes to be paid.  As noted by “given the stingy yields on checking and savings, customers likely didn't earn close to that amount from the accounts they opened.”  Still, customers who received miles as part of the promotion for opening an account will need to risk a discrepancy in the IRS’ calculations (and thus be more likely to be audited) or report the full value of the miles as income.  (LA Times article.)

U.S. Senator Sherrod Brown, from Ohio, pointed out that the practice is not required by law and asked the bank to stop treating the frequent flyer miles as income.  In a letter to the Citibank CEO, the Senator mentions a 2002 IRS ruling excluding frequent flyer miles from income.  (Sherrod Brown press release.)   In that ruling, the IRS stated that frequent-flier miles are not subject to income tax due to the “numerous technical and administrative issues relating to these benefits” and that 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.”