In Short:
Recent reports that a major bank has issued Forms 1099 to customers who received frequent flier miles as a gift for opening a new account have re-focused attention on the difficult question of whether, or when, receipt of such miles is taxable. Since 2002, IRS has taken the position that it will not seek to tax miles received for business travel but used for personal purposes, even though such miles probably do generate taxable income under a technical interpretation of the tax law. Although IRS has stated it agrees that Forms 1009 are appropriate for the bank gifts, there is no indication that it will change its position on business travel miles.
The Full Story:
Today’s tax quote: “This is too difficult for a mathematician. It takes a philosopher.” Albert Einstein
The puzzling issue of whether frequent flier miles received from someone else are taxable, which both mathematicians and philosophers thought had been settled years ago, has recently re-emerged,. According to numerous press reports, Citibank has been issuing Forms 1099 to customers who received awards of frequent flier miles for opening accounts during 2011. This has come as a surprise, since the Internal Revenue Service had announced in 2002 that in most cases it would not pursue taxability of frequent flier miles.
Prior to 2002, the issue had generated a great deal of interest, and confusion. It is clear that frequent flier miles received and used by travelers as a result of their own personal travel, or for their personal stays at hotels or their use of rental cars for example, are not taxable. They are in the nature of discounts.
However, business travelers who are permitted to keep and use frequent flier miles earned from deductible business travel, particularly travel paid for by their employer, arguably should report income and pay tax for the personal use of such miles. Although this result is fairly clear from a technical income tax perspective, it also raises a host of very thorny issues related to the timing of the income (is it when the miles are received, or when they are used, and if the latter, how are taxpayers and the IRS supposed to track and document the income?) and valuation (do the miles have some determinable fair market value when received, or is the value of the benefit only determinable when the miles are used?). There are also very difficult administrative issues relating to how to separate nontaxable miles from taxable miles, and who would do the reporting and tracking required. For example, an employee who earned miles on business travel would have to determine whether they were subsequently used for more business travel (not taxable) or personal travel (taxable).
As a result, in 2002 the IRS in effect threw up its hands and announced that it would not seek to tax personal use of frequent flier benefits received as a result of business travel, and that if it changed its mind later it would seek to tax only benefits received thereafter. See Announcement 2002-18, available at http://www.irs.gov/pub/irs-drop/a-02-18.pdf.
However, IRS was careful to limit its concession. It stated that “this relief does not apply to travel or other promotional benefits that are converted to cash, to compensation that is paid in the form of travel or other promotional benefits, or in other circumstances where these benefits are used for tax avoidance purposes.” The meaning of this sentence is, however, not a model of clarity, to say the least.
Which brings us back to Citibank. Apparently, Citibank had a program under which it gave customers who opened new bank accounts 40,000 frequent flier miles. As explained in IRS Publication 550, when a bank gives a customer a noncash gift for opening an account, the value of the gift is treated as additional interest and reported on the customer’s Form 1099 as such. The publication includes an example of a customer who receives a $15 calculator for opening a saving account, and says that the value will be reported as additional interest.
Citibank interprets the rule stated in Publication 550 to apply to its gifts of frequent flier miles. Since the customers who complained to the media received Forms 1099 including an extra $1,000 of income, it appears that Citibank valued the miles at 2.5 cents each (which has been reported at other times as an amount some merchants pay to the airlines for the miles they use in promotions). However, needless to say this came as a shock to the recipients.
Amid threats and entreaties from legislators (Senator Sherrod Brown of Ohio, who is Chairman of the Senate Banking Committee, has written to Citibank citing Announcement 2002-18, and demanding that Citibank halt its reporting practice), Citibank has so far held firm, and its case was bolstered by a statement from the IRS that “when frequent flier miles are provided as a premium for opening a financial account, it can be a taxable situation subject to reporting under current law.” Apparently, IRS does not view its 2002 Announcement as applicable to this situation.
So far, nothing that has been done or said has suggested that the IRS position taken in 2002 concerning personal use of frequent flier miles obtained on business travel is in any jeopardy, although tax professionals and companies are watching the situation with some concern. (It is understood that in any event, many companies have policies in place that do not permit company travelers to use miles earned on company travel for personal purposes). But if nothing else, the Citibank Forms 1099 illustrate once again the difficulty of determining a value for unused frequent flier miles. Although Citibank may have paid 2.5 cents for each mile it used, that does not necessarily have anything to do with the value of those miles to the recipient. Presumably, no citizen in his or her right mind would voluntarily pay $1,000 for 40,000 frequent flier miles which may wind up being used for flights costing far less, or not being used at all.
Although the renewed attention to frequent flier miles may have no immediate impact except on the unfortunate recipients of the Forms 1099 at issue, it provides a very interesting commentary on the difficulty inherent in applying our tax laws. As Dr. Einstein said, it may require a degree in Philosophy.
Posted by Peter K. Scott