Credit card rewards are the common motivation for people to purchase goods or services and get more receive reward points. When you use these credit card rewards points to acquire further goods or services or even converting to cash, a natural question must arise ” How are credit card rewards taxed?”.
Now, these reward points are not considered till when you use the points to buy the reward of the good. The rationale behind this is that the rewards act as a discount on the consumer’s property or services. So, IRS does not try to tax such redemption of reward points.
Cashback credit card rewards to a savings account ?
In an interesting ruling in the case of Konstantin Anikeev and Nadezhda Anikeev v. Commissioner of Internal Revenue , the United States Tax Court held that the redemption of credit card reward points, which are earned from buying ‘cash equivalents’, shall be liable to tax.
The facts of the case were that the taxpayer had two American Express credit cards (Amex Cards) which were used to buy Visa Gift Cards and then used those visa gift cards to buy money orders. The next shrewd step was to deposit the money orders into his bank account. Ultimately, the money so credited was used to pay the Amex credit card bills.
Here comes IRS !
While the move by taxpayer was intelligent, it caught the attention of the IRS who usually do not tax redemption of credit card points for buying goods or services on the ground that those points are basically rebates on goods. But, in the case of Mr Anikeev, facts showed that rewards points were converted to cash and not used for acquiring goods or services. Therefore, IRS considered such redemption of credit card points as ordinary income.
It was a case of IRS that Mr Anikeev did not pay tax on additional income totalling $35,665 for 2013 and $276,381 for 2014 on the basis of rewards that petitioners acquired from American Express equal to 5% of their purchases of prepaid Visa gift cards, debit cards, and money orders and that were paid to them in the form of statement credits against their American Express bills.
IRS proposes to tax as ordinary income,Court holds otherwise
The IRS tried to tax the reward dollars as an ordinary income, but the Tax Court held that the American Express Rewards Program as offered to Mr Anikeev can never be seen as ordinary income because the reward scheme was essentially a purchase-price discount. But the Court opened the door for the IRS to argue that the Visa Gift Card could be viewed as an asset with a basis equal to its cost. Though the face amount might be $10,000, under Internal Revenue Code (IRC) section 1012, its cost basis would be $9,500—so that when it is exchanged for a $9,900 Money Order, there is gain ($400)—and realized gain is clearly taxable.
Section 61(a) of the IRC defines gross income broadly. The United States Supreme Court has said that it has a ‘sweeping scope’. On the other hand, the Anikeev court noted that adjustments to the purchase prices of goods or services have consistently been considered non-taxable. The court observed that the Treasury Department’s own Revenue Ruling held that the receipt of a rebate by a retail customer does not result in the receipt of gross income. Rather, the rebate was a reduction in the purchase price, requiring a downward adjustment to the basis of the automobile pursuant to section 1012 of the IRC.
The Court also noted the longstanding IRS policy that card rewards are not taxable but held that the Anikeev clearly got capital gains as the converted dollars from reward points reduced Anikeev’s bases in the Visa gift cards and generated proceeds when they converted the cards to money orders.