Louis DeNicola is expecting a 1099 tax form to arrive in his mailbox any day now. A personal finance writer for Saveful.com, Louis is no stranger to the process. He opens up bank accounts every year to take advantage of special promotional offers - usually, these can reward him with anywhere between $100 and $250 each. Louis isn't alone in this. Every year thousands, if not millions, of Americans receive points, miles, or cash from various banking promotions - whether it be for opening up a new account or through credit card rewards.
Stories about paying taxes on rewards seem to proliferate the internet around every tax season. This results in a lot of myths and misinformation floating around. Consumers should be aware of when "free" isn't "tax free". Even if you don't use your reward points, you may still be required to pay taxes that are based on their fair market value. This short guide will give you an idea of when to expect a tax document from your bank.
When You Might Have To Pay Taxes On
If you received the rewards for engaging in business with a bank, you may be required to pay taxes. This includes things such as opening up a new bank account, but excludes rewards earned as a result of transactions (more on those below). Louis advises those who receive a bonus to put it aside in a savings account. "[This way] you won't be tempted to spend it and you can earn a little interest until you need to pay taxes" he explains.
The practice of paying taxes on rewards, for the most part, didn't exist up until a few years ago. In 2011, Citibank mailed 1099 forms to customers who signed up for their Citigold Accounts, and received ThankYou points as a result. To the outrage of many customers, not only were those who received the bonus taxed, the points were also valued at 2.5 cents each -- much higher than the average value of a ThankYou point which stands at around 1 to 1.25 cents. The situation forced the IRS to take the issue to court. In 2014, the Tax Court ruled that these points could, in fact, be taxed, and opened the door for more issuers to engage in the practice.
When You Won't Have To Pay Taxes
Whenever you earn rewards on a credit card for spending money - whether it be cash back, points, or miles - you will generally not be required to pay taxes. The IRS views such transactions as a rebate or price reduction on your purchase. For example, if you buy a product valued at $100 with a card offering 2% cash back, the IRS doesn't view it as you earning $2. Instead, it treats it as if you received a $2 rebate on that initial purchase. The same rule applies to credit card welcome bonuses. Since most of these require you to spend some amount of money in order for them to kick-in, they are also considered to be a rebate.
Things get a little more questionable with cards that offer you other perks, that don't require any spending. For example, some hotel credit cards will offer a free nights at their properties. Given the logic followed by the IRS thus far, it would seem that these gifts can be taxed. However, there has been no actual 1099s sent out to consumers as of yet - and no precedent has yet been set.
If You Are Unsure of Anything Seek Professional Help
If you at any point you are confused as to whether or not you should report something to the IRS, seek the advice of a professional. While these types of guides can give you a good idea of what to expect, they are no substitute for a professional financial adviser or tax accountant who can walk you through your individual situation in greater detail.