Tax season is here, and you're no doubt busy gathering all of your tax-related documents. As you do this, you might also be wondering if your credit card rewards are taxable.
This issue started getting attention in 2012 when Citi issued 1099-MISC forms to cardholders who had received frequent flyer miles as a gift for opening an account. Imagine how surprised Citi customers were when they learned that their gift wasn't free at all but was considered taxable income by Citi, valued at 2.5 cents each. The result was a class-action lawsuit filed against the company, which it settled.
Although it was a headache for all involved, this situation did help to clarify which credit card rewards and bonuses are taxable and which are not. You'll be pleased to hear that, in most cases, rewards aren't taxable, but there are exceptions.
Here's When Your Rewards Income Is Taxable
Whether credit card rewards are taxable depends on how you earned them. If you received cash or miles, for instance, for simply opening an account, you might have to pay taxes on the amount.
Here's why: You didn't have to earn the rewards by spending your own money. So, in effect, it's considered taxable income by the IRS. The amount you'll owe depends on the form your credit card issuer uses.
I know it sounds complicated, but there's a simple way to determine if your rewards are taxable. I'll break it down into bite-size parts:
-- Credit card sign-up bonuses.
-- Tax form 1099-INT.
-- Tax form 1099-MISC.
[Read: Best Rewards Credit Cards.]
Credit card sign-up bonuses.
When it comes to sign-up bonuses, things get a little murkier. Depending on how you earned the bonus, the points may or may not be taxable.
Let's say you opened a credit card that offered a 60,000-point bonus for meeting a spending requirement of $4,000 within the first three months of opening the account. If you met the requirement and earned the bonus, you wouldn't have to report the points as income because you spent your own money to get the bonus.
Here's where it can get sticky: If you didn't have to meet a spending threshold and you were awarded the points for simply opening an account, the value of those points would be considered taxable income to the IRS.
The amount you'll owe in taxes depends on what type of 1099 form your financial institution issues.
Tax form 1099-INT.
This form is used to report interest income, such as interest earned in a savings account. The IRS requires a 1099-INT for interest income of $10 or more, which is taxed at the same rate as ordinary income. You might actually owe both federal and state income taxes, depending on which state you live in.
Tax form 1099-MISC.
As in the case of Citi, where the reward wasn't earned, there's a chance your bonus could be reported as miscellaneous income. This is a catch-all for income outside of regular wages, such as income earned as an independent contractor, via rent payments or through royalties. The IRS only requires a 1099-MISC to be filed when the income is $600 or more.
But keep in mind that even if you don't receive a 1099 form, you still have to report all qualifying taxable income.
Here's When Your Rewards Income Is Not Taxable
Fortunately, most of your credit card rewards aren't taxable. Let's take a look at each type of reward:
-- Earning points with purchases.
-- Earning airline miles for free or discounted flights.
-- Earning cash back rewards.
Earning points with purchases.
Some credit cards offer a point system that you can redeem for gift cards, travel expenses or statement credits. As long as you have to spend money to earn the reward, your points or miles aren't taxable.
Earning airline miles for free or discounted flights.
Travel rewards credit cards offer you opportunities to save on travel. If you use your cards strategically, it's possible to accrue thousands of miles that you can use to subsidize your travel. In an April 2019 U.S. News survey, respondents reported earning between $351 and $1,750 in travel rewards over the past year.
Again, the key is whether the miles were a gift or if you had to spend your own money to earn the miles. If you earned 2 miles per dollar spent on purchases, for example, then you're in the clear. You've basically earned the miles, but the result is a discount on purchases.
Earning cash back rewards
Cash back rewards are always popular with consumers. These credit cards are usually easy to use, and you can earn rewards on everyday expenses. Like other rewards credit cards, if you have to meet spending thresholds to earn the welcome bonus or make purchases to earn rewards, your earnings are viewed as a rebate and not as taxable income. The same goes for miles, points and any other credit card rewards you earn for meeting certain spending requirements.
When Are Business Credit Card Rewards Taxable?
The tax treatment for rewards earned using business credit cards is similar to the rules for consumer cards. And many business credit cards come with generous rewards and sign-up bonuses.
But even if you had to earn the rewards or attain a sign-up bonus by making purchases, you must be careful when writing off business expenses. This means keeping excellent records of what you spent and what was reimbursed with rewards. You aren't allowed to deduct the full expense if you used rewards to offset the cost.
For example, let's say you went on a business trip and redeemed $400 in reward miles to purchase a $600 ticket. You can't deduct the entire $600 because you didn't have to pay that amount. But you can deduct the $200 difference.
So, in general, business credit card rewards are not taxable income, but you do have to keep track of any rewards you use to pay for business expenses. You can only deduct the amount you actually paid.
[Read: Best Business Credit Cards.]
But given that we're talking about taxes, you won't be surprised to hear that this can get even more complicated. What if you decided to use your business card rewards for personal travel?
OK, if you used your rewards to buy a plane ticket for vacation, the IRS is giving you a break. The IRS ruled that it will not consider the rewards taxable income. Just be sure you don't double dip and try to deduct your personal expenses as a business expense. The IRS would not look favorably on that.
And one more tax-related issue you need to be aware of involves charitable donations. There are many credit cards that make it easy for you to donate rewards, such as miles, to charity.
But remember, rewards are considered discounts on the amount you have spent to make a purchase and not income. So you can't write off any rewards you donate to a charity.
Now, if you want to use cash back rewards and donate actual cash, that's different. The rewards aren't income, but they can be allowed as a deduction on your taxes. Be sure you get a receipt when you make a donation with cash.
How to Avoid Taxes on Your Credit Card Rewards
These days, most credit card rewards are rarely taxable because there's usually a spending requirement to earn a welcome bonus as well as to earn rewards. Stick with offers where you have to use your card to earn rewards or to get a sign-up bonus and you'll be fine.
But if you have an opportunity to get a reward or bonus without any spending on your part, think carefully before you open the account. Your "free" gift is considered income, so run the numbers and determine your tax liability in these cases.