Monthly Archive: October 2014

Credit card frequent flyer miles are not taxable – but miles earned for opening a bank account are.

I don’t often get to think about the tax implications of my personal hobbies.  Perhaps if I was an amateur horse breeder, I would have more opportunity.  However, as an avid frequent flyer miles collector, the following case makes me nervous.

The Tax Court recently ruled in Shankar v. Commissioner (2014, 143 T.C. 5) that the value of an airline ticket redeemed with frequent flyer miles was an item of gross income.  In this case, Shankar opened a Citibank bank account in 2009, received 50,000 Thank You points for opening the account, and then redeemed them in 2009 for a domestic round trip ticket.

It is accepted practice (Announcement 2002-18, 2002-1 C.B.621) that frequent flyer miles earned by flying an airline, earned by signing up for a new credit card, or earned through regular credit card spending is a non-taxable refund or discount on the the purchase price of an airline ticket (or a discount of other credit card spending if received on a cash back credit card).  It is also accepted law that cash bonuses earned on opening new checking accounts are taxable as interest in the year of receipt.

For years, Citibank has issued Form 1099-MISC’s to customers who opened bank accounts and received noncash points, with Citibank assigning a value of 2.5 cents per point.  However, in the Shankar case, Citibank took it a step further and used the actual cash value of the airline flight redeemed for points.  In this case, the cash value of the flight resulted in taxation of 1.3 cents per point, less than the 2.5 cents that Citibank has previously been using.  However, if Shankar had instead redeemed his points for a first class ticket worth thousands of dollars**, the economics of this dispute would have been completely different. Furthermore, it is unclear how Citibank is going to proceed when points are redeemed in a future year.

Going forward, it is important to recognize that cash bonuses earned when opening bank accounts are taxable income.  It is currently unclear how other banks will be handling the award of noncash points when a bank account is opened, but it is safe to say that I would avoid opening a bank account at Citibank if at all possible.  Who knows why Citibank is prompting the IRS to act when the IRS really has no desire to do so.

**Yes, this is why this is a legitimate hobby.  Getting free travel for doing something that you were going to do anyway is fun.

 

Non-cash donations: You may not survive an audit unless you follow these simple rules.

A recent Tax Court case (Smith, TC Memo 2014-203) disallowed nearly $27,000 of non-cash charitable donations (i.e. donations of clothing and household items to a thrift store such as Goodwill, Salvation Army, or the National Council of Jewish Women) due to the taxpayer’s failure to substantiate the donation.  The Tax Court ruled this way despite there being “no doubt” that the donations actually occurred. While many taxpayers believe that a donation receipt is sufficient, the truth is, as it always is in tax law, “it depends.”

In general, all charitable contribution deductions must be substantiated, although the level of substantiation depends upon the fair market value of the contribution and whether cash or other property was donated. Contributions of cash or property valued at $250 or more are allowed only if there is “a contemporaneous written acknowledgement of the contribution” by the donee organization (Internal Revenue Code Section 170).

For non-cash contributions of $500 or more, donated items must be categorized and total values for the year must be aggregated into these categories.  Examples of categories include clothing, household items, furniture, jewelry, electronics, etc.  Furthermore, under Reg. Section 1.170A-13, taxpayers are required to have written records of the following:

1) The acquisition date and how it was acquired (i.e. purchase or gift);

2) A description of the property;

3) The cost or other basis of the property (i.e. what it was purchased for);

4) The fair market value of the property at the time of contribution; and

5) The method used to determine fair market value (i.e. thrift shop value).

For non-cash contributions of $5,000 or more, the taxpayer must follow the substantiation requirements for contributions of $500 or more AND must also obtain a “qualified appraisal” of the items and attach it to the taxpayer’s tax return.

The actual specifics of the Smith Tax Court case are almost irrelevant, since Smith kept virtually no records whatsoever.  What is important to draw from this case, however, is that form often matters more than substance. The Tax Court had no doubt that a substantial charitable donation was made – yet it was disallowed completely because the rules were not followed. If, however, the substantiation requirements were nominally followed, the result would likely have been different.

If you would like to find out the best way to substantiate your charitable donation or have any questions about the charitable donation rules in general, please don’t hesitate to contact us.

Daniel Schwartz has been published in the April issue of Valley Lawyer!

Daniel Schwartz’s article, “Stop the (Tax) Bleeding: Medical Expense Deductions for Self-Employed Individuals”, has been published in the April issue of Valley Lawyer.

AS A RESULT OF THE Affordable Care Act, high-income taxpayers will experience painful increases in income and payroll/self-employment taxes beginning with their 2013 income tax returns. With combined rates of federal, California, and payroll/self-employment taxes easily exceeding 50%, those high-income taxpayers who didn’t plan for 2013’s tax changes will be especially shocked and will be looking for ways to reduce their tax bill.

You can read the whole article here – please scroll to page 14.

 

Daniel Schwartz has been published in the October issue of LA Lawyer!

Daniel Schwartz’s article, “Tax Consequences of Business Entity Choice”, has been published in the “Barrister’s Tips” section of the October issue of LA Lawyer.

WHEN ADVISING A CLIENT that wishes to form an entity for a closely held, operating business, it is important to carefully delineate the differences in tax consequences among limited liability companies (LLCs), S corporations, and C corporations. Although the default choice for most business attorneys is to suggest a pass-through entity, such as an LLC or an S corporation, clients—and sometimes their attorneys—do not always understand the tax differences between these two business forms. Also, while it has become rare, there can be situations in which, from a tax perspective, a C corporation may be preferable to a pass-through entity. Since all three business entities provide limited liability and corporate formalities are relatively inexpensive to implement, the tax consequences of the choice of business entity may be the most important factor to consider.

You can read the whole article here.