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.