You probably never paid a penny in taxes for the frequent flyer miles you've earned. I certainly haven't.
There's only one exception to the no-tax-on-miles rule, as it's been generally understood. If you win frequent flyer miles in a contest or sweepstakes, the sweepstakes host publishes an estimated retail value of the miles in the terms and conditions, and sends a 1099 form to the winner and to the IRS, which considers the prize's value to be tantamount to extra income and taxable as such.
On the other hand, there are no tax consequences for earning frequent flyer miles for day-to-day transactions, such as shopping, traveling, and so on.
But what about the miles that banks award as incentives to open checking and savings accounts? Or the miles that credit card issuers routinely give to consumers as an incentive to apply for new cards?
Until recently the prevailing assumption on the part of both mileage-earners and tax experts was that such sign-up bonuses were not taxable.
This year, however, as reported by the Los Angeles Times, Citibank began sending 1099s to customers who had received mileage bonuses for opening savings or checking accounts. And of course, copies of those 1099s were also sent to the IRS.
Citi's move—which it claims is in response to IRS guidelines—raises a host of questions and concerns. Among them:
Citi valued the AAdvantage miles awarded for opening checking and savings accounts at 2.5 cents each. While it's possible to get that much value for the miles when redeeming them, my estimate of the average value of a mile is around 1.2 cents. And certainly Citi paid American much less than 2.5 cents apiece for the miles. In fact, the vagaries of valuation are one of the issues that the IRS has historically cited as an insuperable barrier to taxing miles.
What's the difference between earning miles for opening a bank account and miles earned for signing up for a credit card? If the former incentive is taxable, why isn't the latter? With the marketplace awash in lucrative credit card sign-up bonuses, this question is hardly academic—hundreds of thousands of consumers would be affected if credit card bonuses were treated like bank account bonuses.
And if bonuses for financial services transactions are taxable, wouldn't that suggest that miles earned for other transactions were taxable as well?
According to David Lazarus, who wrote the L.A. Times story, the IRS considers the bank account bonuses to be "income miles," while other bonuses are "rebate miles." The logic of that distinction eludes me.
So, what to do? This is what Eva Rosenberg, my tax advisor and publisher of TaxMama.com, advises: "ANYTIME you get a 1099 form of any kind, report it on your tax return wherever the IRS computer expects to see the income. In this case, on Line 21, Other Income. Then, if the income is not taxable, deduct it back out, and include a statement explaining why it's not taxable."
I'm sure that's solid advice. But I'm equally sure that any policy that causes so much confusion, and that requires taxpayers to report, back out, and then explain themselves, is a policy that needs to be rescinded.
Apparently Senator Sherrod Brown (D-Ohio), chairman of the Senate Banking Subcommittee on Financial Institutions and Consumer Protection, agrees. He appealed directly to Citi chief Vikram Pandit to "end this gratuitous practice. The Internal Revenue Service (IRS) clearly stated that frequent-flier miles are not subject to income tax."
Since there's obviously disagreement as to the interpretation of the IRS' rules, frequent flyers can only hope that he and like-minded politicians will take the no-tax case to the IRS as well.
Reader Reality Check
Did you earn miles for opening a new savings or checking account in 2011? Did the bank send you a 1099 for the miles?
This article originally appeared on FrequentFlier.com and SmarterTravel.com.