What to know about credit card rewards and taxable income
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The obvious upside that draws so many people into the world of credit card rewards is the ability to save hundreds or even thousands of dollars a year on travel, while simultaneously enjoying valuable travel and lifestyle perks. Any time you receive something of value, whether as a gift, a payment or a benefit, you should also consider the tax implications to make sure there are no unpleasant surprises come April. Today we're going to attempt to answer the frequently asked question, "are credit card rewards taxable income?" Keep in mind, we're not tax professionals and you should definitely consult with one if you're not sure of the correct direction for you.
What the IRS says
Quick, what are the two main types of credit card rewards you can receive? If you said cash back and points/miles you'd be right from an award travel point of view, but the IRS has a different take. For tax implications, the IRS classifies your credit card rewards as either bonuses or discounts. Discounts and rebates put more money in your wallet, without creating a taxable event. If you buy a $100 sweater on sale for $75, you end up with an extra $25 in your pocket, but the IRS doesn't tax you on that money. Similarly, you aren't taxed on credit card rewards that are classified as "post purchase discounts."
This should come as good news to nearly all award travelers, but when you earn points as a direct result of spending money, the IRS treats those as non-taxable discounts. This means that the standard welcome bonuses (for example, "spend $3,000 in the first 3 months and earn 50,000 miles") as well as the subsequent earning on actual purchases (earn 2 miles per dollar on dining and 1 mile per dollar on all other purchases) are generally not classified as taxable income.
Together, these two categories account for an overwhelming majority of credit card rewards, meaning that most award travelers don't have to worry about the tax implications of earning flights, hotel stays, or even cash back. The one notable exception is referral bonuses, as many card issuers allow you to earn bonus points or cash back for referring a friend who gets approved for a new card. In that case, the rewards you're earning aren't contingent on you spending money, so they would be taxable income.
There may be instances where the card issuer will do some legwork, and you may receive a 109-MISC or 1099-INT if they've given you taxable rewards. There may also be times when the issuer is not required to send the 1099 form – so, since the issuer doesn’t always send the 1099, it’s important for you stay on top of your own tax planning. We've seen a couple instances in the past few years of banks erroneously sending these forms to customers whose rewards should not have been taxed, or not sending them out to customers who did earn taxable rewards, so it's important to be your own advocate here to make sure your tax obligations are met. To sum it up: just because you get a form doesn’t necessarily mean liability, and if you don’t get a form, that doesn’t necessarily mean there’s no tax liability.
Personal vs. business
One important exception comes for those who use business credit cards. While there's no difference in whether rewards earned on business credit cards are taxable, those rewards do lower your purchase price, affecting how much of a deduction you can claim for qualified business expenses. Business credit cards still offer a large number of benefits, including expense management and keeping large expenses off your personal credit report, but this accounting quirk is worth keeping in mind when you go to prepare your business tax return.
Sometimes it feels like credit card issuers make us jump through a lot of hoops to earn points, as they increasingly shift towards multi-tiered welcome bonuses that require a greater amount of spending over a larger period of time. The good news is that by engaging in this quid pro quo type of spending pattern, the rewards we earn are not taxable. If the banks simply gave bonuses to anyone who opened a card without requiring a certain amount of spending, we would have to pay taxes on the value of those rewards and our bonuses would be worth less. With all that being said, it’s important to consult a professional tax advisor about your specific circumstances and tax obligations.