It used to be that when you opened a new account at a bank or other financial institution, you got a free pen. Or, if the bank was feeling really flush, a toaster.
These days, however, banks are wooing customers with more valuable incentives like frequent flyer points. Those incentives now come with a price: the Tax Court has sided with the Internal Revenue Service (IRS) in attempts to tax the value of an airline ticket redeemed with “Thank You Points” from opening an account with Citibank.
Citibank, of course, brought this on itself. You may recall that, in 2012, Citibank announced that it would issue a form 1099 for those customers who receive frequent flyer miles – called “Thank You Points” – for opening accounts. Citibank allegedly didn’t make this disclosure to its customers at first (in 2011, their promotional materials contained the helpful line, “Customer is responsible for taxes, if any.”) Nor did it print the value of the miles on its promotional materials. The announcement after the fact triggered a class action lawsuit against Citibank alleging that the banking giant failed to adequately notify customers of the potential tax consequences and further, that Citibank inflated the value of the miles for purposes of issuing the tax forms. Sen. Sherrod Brown (D-OH) even sent Citibank a letter asking them to stop sending “unnecessary forms” to taxpayers.
Not all banks agreed with Citibank’s position. When Citibank announced the practice in 2012, explained that they treat the miles more like a rebate – just as the airlines do (those miles are generally considered nontaxable).
Tax pros also weighed in on the matter, most coming down on the side of “not taxable” with many saying that the issue would not have even been raised if not for the issuance of the form 1099 by Citibank. Not reporting the income once it’s been deemed income by Citibank could result in an audit.
While these debates were going on, the IRS remained curiously quiet. The IRS position since 2002 (announcement downloads as a pdf) has been that frequent flyer miles earned due to business travel are not taxable. The IRS has taken the position that it “will not assert that any taxpayer has understated his federal tax liability by reason of the receipt or personal use of frequent flyer miles or other in-kind promotional benefits attributable to the taxpayer’s business or official travel.” The notice went on to say that, with respect to promotional benefits, “the IRS has not pursued a tax enforcement program with respect to promotional benefits such as frequent flyer miles.”
Until now. Thanks, Citibank.
In Shankar v. Commissioner (downloads as a pdf), decided earlier this week, Citibank issued a form 1099 to the taxpayer in the amount of $668 for redeeming “Thank You Points” for an airline ticket. Citibank supported the IRS position at trial by providing an affidavit confirming the amount of the ticket.
Thankfully, the Tax Court did draw a distinction between the taxability of “Thank You Points” and frequent flyer miles attributable to business or official travel using Announcement 2002-18 (linked above), wherein the IRS made clear that they would not tax frequent flyer miles attributable to business travel. But that’s where the good news for taxpayers stopped.
In a case of what could be characterized as bad facts making bad law, taxpayers didn’t put up much of an argument for not including the income on the tax return: there was no lengthy brief explaining why it might be excludable. Nor did the IRS say much about the inclusion: they more or less took the position that Citibank’s form was enough to prove income, triggering the Tax Court to decide that “we give more weight to Citibank’s records.” The Tax Court then, had to “proceed on the assumption” that the points were a premium for a deposit. Under section 61(a)(4), then, they reasoned, it would be considered gross income. Section 61(a) defines gross income to mean “all income from whatever source derived” including a list of specifically taxable items. Subsection (a)(4) is just one word on that list: interest. The Tax Court’s reasoning, then, seems to be that Citibank classified the “Thank You Points” as interest saying that it was “something given in exchange for the use (deposit) of [taxpayer’s] money.”
I think that’s a bad result. I also think that Tax Court was backed into a corner with an overly aggressive initial interpretation of the law by Citibank which, it should be noted, made the issue an issue before IRS or Tax Court had taken an official position.
The entire discussion of whether to include the 1099 as income took up just three paragraphs of the opinion. As a result, I don’t expect the entire issue to be settled with this ruling. Notwithstanding that I don’t agree with the result, I think the finding raises potentially more confusing issues for taxpayers, including what happens when/if the points expire. If the points are included as income and later expire, would that be a nontaxable event – or would the inability to use them result in some sort of loss? I also find it somewhat unclear from the ruling whether the tax trigger should be the issuance of the points – which would support the interest argument – or the redemption of the points for a ticket.
For the record, when I first wrote about this in 2012, Citibank contacted my editor to talk about the story. They weren’t too happy about my characterization of what they were doing. They really, really wanted me to emphasize the part of the IRS position that the miles “can be a taxable situation.” Emphasis on “can.” It was almost as if the bank wanted the miles to be taxable, a position that I questioned, writing, “I remain perplexed as to why Citibank chose to make this an issue with taxpayers and IRS when the IRS has been very clear since the 2002 Notice that it will not aggressively pursue these matters if they do not appear to be abusive. If you have additional commentary for my story, I am happy to include it.” In response, Citibank did not offer additional information, merely pointing me to the Notice I previously cited in my piece and then following up with a statement from CCH where the IRS stated, “When frequent flyer miles are provided as a premium for opening a financial account, it can be a taxable situation subject to reporting under current law.” Emphasis on “can.”
I’m sure Citibank feels vindicated by the ruling. I have to wonder, however, how their customers feel.
It almost makes you yearn for the days of free toasters.
