What does the Tax Court decision mean to you? Let’s explore the ramifications of the Tax Court’s decision in an Explainer.
How can frequent flier miles be income? They’re not money.
The tax definition of income is much broader than just money. Basically, if you’d include it in your gross income if it were paid to you in cash,[fn1] you need to include it in gross income if it’s paid to you in property or in services. For example, if you spend half an hour teaching a piano lesson, and your student pays you $30, you have $30 of gross income. If you teach the piano lesson and your student gives you Burger King shares worth $30, you still have $30 of gross income, even though you didn’t get any cash.
Frequent flier miles are a type of property; there’s nothings special about them, and no reason that they can’t be included in your gross income.
Did I break the law all those times I got frequent flier miles and didn’t pay taxes on them?
Probably not. Even though frequent flier miles fit within the scope of gross income, in 2002, the I.R.S. announced that it would not accuse taxpayers of underreporting their income if they didn’t include in their gross income frequent flier miles they earned on business trips. Any change in the policy, the I.R.S. said, would only be applied on a prospective basis.
It’s important to note what the I.R.S. didn’t say: it didn’t say that frequent flier miles earned from business trips weren’t income. It only said that, income or not, it wouldn’t go after taxpayers that didn’t include the value of those miles on their tax returns.
Then why did the I.R.S. go after Mr. Shankar?
Mr. Shankar’s frequent flier miles weren’t from personal or business travel.[fn2] Rather, the were Citibank “Thank You Points,” awarded because Mr. Shankar opened an account with Citibank.
So I’m taxable on the receipt of frequent flier miles from a bank?
That’s actually not what the court says; in fact, it leaves open the question of whether the receipt of frequent flier miles is a taxable event.
Rather, the taxable event appears to be Mr. Shankar’s use of his frequent flier miles. That is, when he decided to take a trip, Citibank purchased the ticket with some portion of the Thank You Points.[fn3] The fair market value of the tickets, according to Citibank, was $668. Which means Mr. Shankar should have included $668 in his gross income.
Okay, so if I get frequent flier miles from my bank, I’m taxable when I redeem them. How about if I get frequent flier miles from my credit card?
See, the thing is, there was a lot of ambiguity before the Tax Court’s decision. And, frankly, there’s still a lot of ambiguity. The I.R.S. asserted that the frequent flier miles constituted interest, and Mr. Shankar didn’t dispute that characterization. And interest is clearly includible in gross income.
Could the frequent flier miles have actually constituted interest? Sure. For tax purposes, “interest” is payment for the use of money. When Mr. Shankar opened a bank account, he was, in essence lending money to the bank. In exchange for lending money to the bank, the bank probably paid him some percentage of what was in his account every month.[fn4] But arguably, the frequent flier miles constituted prepaid interest.[fn5]
With credit cards, though, you’re not lending money to a bank; rather, you’re borrowing money. And when you borrow money, you pay interest. You don’t receive it.
That’s not to say that credit card frequent flier miles don’t constitute income. It’s just to say that the reasoning in this case doesn’t get you there. If credit card frequent flier miles are income, it’s not because they’re interest income. And if they’re not interest income, this case has no bearing on their tax consequences.
So how do I know whether I should include my frequent flier miles on my tax return?
Right now, if you receive your frequent flier miles as the result of business travel, you don’t have to include them on your tax return. Presumably, in fact, any frequent flier miles you receive as the result of traveling, whether it be business or personal travel, doesn’t need to be included.
If you get frequent flier miles as the result of opening a bank account? It’s not clear. The court didn’t deal with that question. Ditto if you get the miles from your credit card. Those are still in limbo: there’s no reason they couldn’t constitute income, but neither the I.R.S. nor the courts have told us they do.
The one thing this case clarified was that using frequent flier miles received for opening a bank account is income. At least if those frequent flier miles can be considered interest.
Which is to say, the case doesn’t tell us much of anything. What was muddy before is muddy still.[fn6]
h/t Paul Caron.
[fn1] Note that not all cash you receive is gross income to you. Gifts, for example, aren’t included in gross income, even if they’re paid in cash.
[fn2] The I.R.S. doesn’t say anything in its announcement about frequent flier miles earned on personal, rather than business, trips. But it implies that it also won’t require taxpayers to include those miles in gross income.
[fn3] The opinion doesn’t say whether the ticket used all 50,000 of his points, or whether he had points left.
[fn4] Of course, that amount was probably virtually nothing in today’s interest environment.
[fn5] I haven’t thought hard about whether, in fact, the Thank You Points would or should constitute interest. But, as a procedural matter, the fact that the I.R.S. characterized them as such in the trial and the taxpayer never disputed the characterization, the court was correct to view the Thank You Points as interest.
[fn6] But seriously, the whole case was over an alleged $563 deficiency (not all of which was the frequent flier miles). Which means, needless to say, the petitioner was representing himself pro se. Which is very likely why he didn’t think to disagree with the I.R.S. when it claimed that the frequent flier miles were interest. Which is why I’m not sure how relevant this case is, even to people who received frequent flier miles in exchange for opening a bank account. But I’m going to have to think about that more.