A Tax Court Case That Could Shock The Miles & Points World

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Credit Card Rewards Are Partly Taxable

Credit Card Rewards Are Partly Taxable Per New Court Case

I first off have to give a big thanks to Derrick from Travel on Point(s) for sending this to us.  I will also say I am not going to give a ton of commentary on this since I am not a legal professional. The purpose of this post is more to share the information so that you can read it for yourself.  But from the court case it appears that credit card rewards are partly taxable.  This is focused on increased spending and not for rewards earned via normal avenues.

Background Info

The case

KONSTANTIN ANIKEEV AND
NADEZHDA ANIKEEV, Petitioners
v.
COMMISSIONER OF INTERNAL
REVENUE, Respondent

Is about a couple that used an old Amex Blue Cash card to rack up cash back rewards.  They did this on a huge scale in 2014, to the tune of over $5M in charges.  The vast majority (almost all) of these charges were for cash equivalents like Green Dot reloads, money orders and Visa gift cards.  With the old Amex Blue Cash they would earn 5% on these purchases at supermarkets and pharmacies once they passed $6,500 in purchases each year.  That means a majority of the $5M in charges earned 5%, to the tune of over $270,000 in rewards in 2014.

The IRS took them to court saying that these earnings should be considered income since no goods were purchased once the gift cards were turned back into cash via money orders and other routes.

Documents

Here is the court case summary:

KONSTANTIN ANIKEEV AND NADEZHDA ANIKEEV Petitioners v COMMISSIONER OF INTERNAL R (1) (1)

Take a look over the documents and then share your thoughts on it in the comments section.  We are hoping to dive into this in more detail after talking with some legal professionals to get their take on it.

Mark Ostermann
Mark Ostermann is a father, husband and miles/points fanatic. He left the corporate world after starting a family in order to be a stay at home dad. Mark is constantly looking at ways to save money and stay within budget while also taking awesome vacations with his family. When he isn't caring for his family or taking a weekend trip, Mark is working towards his goal of visiting every Major League Baseball ballpark.

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35 COMMENTS

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35 COMMENTS

  1. And for the vast majority of us who do NOT get directly into manufactured spend WITH THE OBJECT OF GENERATING INCOME this should be irrelevant and the IRS is not likely to even care. To a large extent, miles and points can be classified as a form of discount for a specific purchase….
    In it’s simplest form, can you imagine getting a discount for paying with cash – and the IRS trying to claim it as income? However, I gather that if you take up the AA offer for generating miles from having a savings account with them, they HAVE to classify the value as income and issue a 1099 in that determined amount…
    And NO, I am not a professional CPA – just a regular small businessman – which means that I need to be fairly aware of what IRS requirements are. In no way can one trust anything that important to a CPA…!

  2. Here is the link to the tax court record: https://dawson.ustaxcourt.gov/case-detail/13080-17

    Does someone have a few dollars to obtain the briefings filed by the petitioner (taxpayer) and respondent (IRS) and send it over? Since this is tax court it’s not on PACER but the filings are public record.

    “Until further notice, requests for copies of Court records from non-parties (copy requests) must be made by telephone and will be fulfilled electronically by email. The Court’s fees with respect to these copy requests will be $0.50 per page, with a per-document cap of $3.00. The Records Department can be reached at (202) 521- 4688.”

    Also, looks like the taxpayer kept good records. LOL.
    TRIAL EXHIBITS FOR 10/4/19 HARTFORD, CT (BAG OF GIFTCARDS EXH 23-P)

  3. Docs said they purchased MOs with Amex cards – interesting how they did that…

    They had 1 card with 1 AU and $15.5K limit (2014), so the churn must have been crazy, and yet AMEX did not blink, and did not shut the account. My guess that AMEX did not report them to IRS, but rather the bank – the one receiving over $4,000,000 in money orders same year. Strangely enough, but the bank did not report it to FBI & Homeland Security – considering such potential “money laundering” activities with personal checking accounts.

    • It may have been a standard legal CTR not a SAR. It’s legal to deposit more than $10,000 in cash equivalents but illegal to structure it.

  4. Holding of the case appears to be that visa gift cards embody a service and so the rebates on those card purchases in the form of credit card rewards are not taxable. However, direct money order purchase with credit cards and direct green dot reloads do not embody a discernible service and the rewards earned are taxable. Since these methods are very difficult these days the primary impact of this ruling is that it may cause the IRS to clarify its rules in a way that impacts everyone.

    I am not a tax lawyer and this is not legal advice. Consult a CPA.

    • I am also not a professional but that is the way I read it as well. VGC were fine because the purchase was a good or service, what they do with it after is outside the scope. Anything purchased directly is treated as taxable.

      Funding a bank account
      Buying a money order with a credit card
      Bluebird/Serve/Green Dot Load
      Using PPK to pay your credit card with a credit card or deposit into a bank

      These things would create taxable income from the rewards. That is my take on it at least (once again not a professional).

      It will be interesting to see what long term effects this has on the tax code for sure.

      • What I do is treat all of this as a business, particularly BFMR activities. Combined with other self-made income, and based on my choices of what I want the outcome to be each year (gain or loss), I can generate SS income quarters (spouse has some $0 years to off-set), or I can generate a loss that off-sets other taxable income that is outside of SS credits. I’ve found that those who reflect back on years of avoiding posting their incomes, they regret that decision when they realize how much larger their SS checks or annuities would be had they claimed at least enough of that income to get 4 quarters of SS income credit per year particularly for a spouse who is not employed outside of the home.

  5. So seems like the case was upholded in IRS favor, with the IRS’ position: “rewards generated where no goods or services are purchased are taxable.” Although court said not to use it widely for all tax applications. Otherwise that can mean that any reward-generating promotions: bonus points for additional users, referral bonuses, and other non-purchase activities, can be considered taxable rewards. If this happens – their value drops 25% on the spot, and CC companies will need to increase them to entice consumers to chase those rewards.

    • Possibly, but I wouldn’t be surprised if those megabanks issuing the credit cards have more influence over our legislators than the IRS does.

  6. Did AMEX pass the information over to the IRS?
    This amount spending much have been from multiple cards. Few managed to MS that much before the limit was capped.
    Some used to say “Be a good steward of MS” or it may end.

  7. This shouldn’t “shock” points and miles people. First of all the cast majority don’t participate in activities like gift cards and other, IMHO, sham transactions. Even if you do use purchase gift cards and actually use them you should be fine. However, if you churn cards by depositing them back to cover card charges or sell them online you are effectively in business to earn money and SHOULD be taxed! No sympathy for those that participate in these activists then complain about taxes (or clawbacks, account shutdowns, etc)

    • Correct, and a fine point to take in is that the taxable activity isn’t the initial MS activity, it’s the conversion activity: “the taxable event would not be the receipt of Reward Dollars upon the purchase of their Visa gift cards but the transformation of the cards into cash equivalents that could be deposited in a bank account…” Thus, the business activity is the work done to earn income to perform the conversions, and the profit from the conversions being taxable from those fruits of labor.

      What is most important for me is, had the Anikeev’s treated the activity as a business, admitted that up front and re-filed their taxes reformulating the costs of business (home office/depreciation; vehicle costs and depreciation; fees; and ideally one led the business paying the other for their labor) it is conceivable that they could have generated a tax loss to claim, versus a hobby gain to be taxed. Of course, “not an attorney, not a tax consultant,” but that’s what I would have done.

      • One part you missed is:

        However, petitioners’ direct purchases of money
        orders and reloads of cash into the debit cards
        using the American Express cards presents a different
        question from the purchase of Visa gift cards. The
        Visa gift cards have product characteristics. They
        provide a consumer service embodied in a simple
        plastic card for convenience. The Visa gift cards
        are not redeemable for cash, but the money orders
        purchased with the American Express cards and the
        infusion of cash into the reloadable debit cards are
        difficult to reconcile with the IRS credit card reward
        policy.

        They seem to separate money orders purchased with a VGC and the money orders purchased directly with a credit card. They are not considered the same or treated the same.

        • Mark, I agree; it became not worth tracking or trying to describe the nuances since the court failed to summarize their categorizations in a simple table at the end of the ruling. What I mostly take away is that a meaningful amount is taxable when you “hobby” at $5M a year.

    • I don’t think many people are turning a notable profit from flipping gift cards though. By no means am I the savviest of MSers, but a few years ago I ran through $60,000 in gift card reselling and couldn’t have made much more than a grand profit. Plenty of points and miles but not much to show as far as profits. I’m sure others have done more and with higher margins but it’s really for the points not the money. This sounds like a fairly unique situation.

  8. Oh boy.. the experts are out. Brant… tons of people do this. You may want to read up about WF. DjG.. Do you have a tax or law background?

    • @Ken, I know that the sun rises in the east and sets in the west but I am not a meteorologist. I know that if I stab my arm I will bleed but I am not a doctor. Similarly, I know income when I see it just like pornography. However, what is most important is, did you read the court ruling? It’s in black and white, both in the intro, as well as the holdings, this was income, the court held most of this to be valid tax debt: “petitioners are liable for deficiencies totaling $9,928 for 2013 and $93,845 for 2014…” with small adjustments for what little the tax court found to be okay as a price adjustment.

      So with the same theme, I do not need to have a tax or law background to be able to comprehend what I read. The income is taxable income: “The money orders are not properly treated as a product subject to a price adjustment because they were eligible for deposit into petitioners’ bank account from acquisition. Similarly, the cash infusions to the reloadable debit cards were not product purchases. The reloadable debit cards were used for Moneygram transfers, which are arguably a service. However, the Reward Dollars in dispute were issued for the cash infusions, not the transfer fees. Therefore, we uphold respondent’s inclusion in income of the related Reward Dollars for the direct purchases of money orders and the cash infusions to the reloadable debit cards.”

  9. The activity was a business undertaking for the purpose of generating income and the income was taxable business income.

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