Airline Miles Taxable?

Citibank's Clients

Citibank recently sent out 1099 forms to thousands of it’s clients indicating that their redeemed airline miles are taxable to the tune of 2.5 cents per mile and listed as miscellaneous income.  This of course caused an immediate uproar not only because Airline miles could cost additional money in taxes, but also because if they’re not reported on your income tax return, the chances that the taxpayer will get hit by an Audit increases (not to mention additional penalties and interest).

Confused taxpayers and tax experts alike began flooding the IRS with calls asking for a ruling on whether miles can be considered taxable. The IRS addressed the issue, however, it appears their ruling only added another dimension of confusion to the issue:

“When frequent-flier miles are provided as a premium for opening a financial account, it can be a taxable situation subject to reporting under current law,” said Michelle Eldridge, an IRS spokeswoman.

OK, so Citi apparently has that part right. But what about miles received for using a credit card or handed out by an airline just for taking a trip?

Eldridge said that in those cases, miles wouldn’t be taxable because they’re more like a rebate.

“A common analogy,” she said, “is buying a $500 television at a retail store and receiving a $50 manufacturer’s rebate. It’s not income, just a deemed reduction of the cost of the television.”

What about valuing the miles? In Citi’s case, the bank is declaring that miles received by customers are worth about 2.5 cents apiece. But tax pros say Citi almost certainly acquired them for less, probably closer to 1 cent each.

“Under the income tax law,” Eldridge replied, “the amount of income to the taxpayer is the value of the property received, not the cost that the business paid to acquire the property.”

Therefore, it doesn’t matter how much the miles were worth to Citi when the bank deducted them as a business expense. The value that must be reported by taxpayers is whatever Citi says it is.

So if Citi is correct about miles being a prize or award for tax purposes, doesn’t that mean virtually all goodies handed out by companies are similarly taxable?

“Whether or not any incentive provided by a business must be reported to the recipient of a Form 1099 depends on the nature, value and other facts and circumstances surrounding the particular incentive,” Eldridge answered.

That’s a fancy way of saying the IRS doesn’t know.

Tom Griffith, a USC law professor who specializes in taxes, said that if frequent-flier miles can be considered income as a prize or award, “in theory, any benefit you get could be taxable.”

But he said the IRS would probably shy away from such thinking because of the administrative headache that would ensue if the agency had to make a call on every single little incentive given out by companies.

“As a practical matter,” Griffith said, “you can see why the IRS wouldn’t want to go there.”

This much is clear: Whomever thought of this over at Citi is probably going to get a huge bonus as Citibank stands to offset millions of dollars in expenses and place them squarely on the shoulders of their clients.  This is not exactly a great way to solidify customer relations and I can see this costing Citi some business.  However, the bigger question is how long will it take other banks to follow suit?  The deadline to issue W2s & 1099s is today–January 31st–so it appears that other banks will have to wait until next year.  Or, will there be such an outcry like there was late last year when Bank Of America tried to impose a $5 surcharge for debit card purchases?  Time will tell, but this doesn’t feel right…but when was the last time a bank too-big-to-fail-bank has done anything for the benefit of their customers?

Source: LA Times