Are Credit Card Rewards Taxable?

Credit card rewards have introduced a whole new level of confusion at tax time. In addition to your salary, bank account interest and other investment income, you might also have to pay taxes on your credit card rewards.

The big question of whether credit card rewards are taxable came to national attention in 2012, when Citibank issued 1099-MISC forms to cardholders who had received frequent flyer miles as a gift for opening an account. That was much to the surprise of those Citibank customers, who quickly learned that the miles weren’t a gift at all: They were considered taxable income by Citibank, valued at 2.5 cents each.

Not surprisingly, cardholders weren’t pleased to learn they were taxed on their rewards, especially because the taxes wiped out the financial benefit of the rewards in many cases. In fact, a class-action lawsuit was filed against the company, which it settled.

As a rewards card user, how can you ensure you don’t end up in the same situation? Understanding tax requirements for credit cards can help you plan ahead and avoid surprises.

The Rules of Credit Card Rewards and Taxes

Whether or not credit card rewards are taxable depends on how you earned them. Here’s a look at the rules surrounding rewards and taxes.

Earning points, miles and cash back: If you have a credit card that offers 2 percent back on spending at grocery stores and gas stations and you earned $20 by spending $1,000 on qualifying purchases, do you have to report that money to the IRS? Fortunately, the answer is no.

[Read: The Best Rewards Credit Cards of 2018.]

The same goes for miles, points and any other credit card rewards you earn for meeting certain spending requirements. “In general, credit card rewards are considered discounts on your purchases,” says Michael Law, CPA and tax expert at Canopy, a tax software company for businesses. “Assuming the credit card purchases are personal [not business] items, then the discount is not taxable income.”

The reason, says Steven Rossman, CPA and shareholder at accounting firm Drucker & Scaccetti, is because receiving a discount isn’t the same as earning income. “It isn’t income to you — it reduced the price of what you purchased,” he says.

Credit card reward bonuses: When it comes to rewards 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 new credit card that offered a 40,000-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.

However, if you didn’t have to meet any spending threshold and were simply awarded the points for opening an account, the value of those points would be considered taxable income.

“The only time that credit card rewards are taxable is when you do nothing in exchange for the reward,” says Rossman. This situation is treated the same as when you earn a cash bonus from your bank for opening a new checking account. The IRS considers it taxable income, and the financial institution may issue a 1099 form reporting that payment.

[Read: The Best Balance Transfer Credit Cards of 2018.]

How much do you have to pay? It depends on what type of 1099 form the credit card company issues.

1099-INT: This form is used to report interest income, such as interest earned in a savings account. According to Rossman, this should be the standard way for credit card companies to report rewards bonuses as well. The IRS requires a 1099-INT for interest income $10 or more, which is taxed at the same rate as ordinary income. So depending which state you live in, it could be subject to both federal and state income taxes.

1099-MISC: As in the case of Citibank, 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. Usually, this type of income is subject to self-employment taxes.

Keep in mind that even if you don’t receive a 1099 form, you still have to report all income, including qualifying rewards bonuses less than $600. The minimum income thresholds requiring a 1099 are for the payer, not the person receiving the payment.

What About Business Credit Card Rewards?

With rewards earned using business credit cards, the tax rules are generally the same. However, there is a special consideration for businesses when it comes to writing off expenses.

“A strict interpretation of the discount for the points received on tax-deductible business purchases would mean you should track the discount against the tax-deductible expenses,” says Law. In other words, if a business expense was partially paid in points or you received a percentage of the expense back as cash, you shouldn’t write off the full amount. Rather, you’d need to subtract the discounted portion and only write off the amount of your actual cost.

For example, if you spent $300 worth of miles for a $500 airline ticket, you wouldn’t be able to write off the full $500 expense because you didn’t actually spend that amount. In reality, you’d only have a $200 deduction once the rewards miles are factored in. So technically, business credit card rewards are not taxable income, but applying rewards to business expenses can increase your overall tax liability.

[Read: The Best Business Credit Cards of 2018.]

“Tracking all those discounts against purchases would be almost impossible, especially when some deductions are limited [to certain categories] like meals and entertainment,” says Law. “Instead, a more practical approach would be anything purchased with the reward points would have zero basis for deduction. If the business points are ever cashed out, then I would include that amount as taxable income.”

In the case of rewards miles that are earned with a business card but used for personal travel, the IRS issued an announcement that it will not consider those points taxable income. So while it might make your bookkeeping a bit messier, you don’t have to worry about any personal tax liability.

One other special circumstance to keep in mind is when business credit card rewards are donated to charity. Typically, since rewards are considered discounts and not income, taxpayers aren’t allowed to write off rewards points donated to charity.

However, according to Rossman, when a company has the option to donate cash back to a charity, those rewards are not only exempt from being counted as income, if applicable, but are also allowed to be written off as a charitable contribution.

For example, say you earned $500 in cash back for opening a new business line of credit, which would be considered income since you didn’t have to meet any spending requirements. However, you decide to donate those rewards to a charitable organization instead. Not only would you not have to pay taxes on the $500, you would also be able to take a $500 deduction. You “must receive the appropriate acknowledgment from the charity,” Rossman says.

How to Avoid Taxes on Your Credit Card Rewards

For personal credit cards, rewards are rarely taxable since most issuers have some sort of spending requirement associated with the points you earn on purchases and sign-up bonuses.

Still, it pays to watch out for large bonuses that don’t require any action on your part other than simply opening an account. Those points are considered income, and you’ll be expected to report them on your taxes, even if you didn’t receive a 1099 form. As long as you stick with cards that award bonuses for spending, you’re not likely to be subject to taxes on your rewards.

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Are Credit Card Rewards Taxable? originally appeared on usnews.com