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  • Writer's pictureAaron Mullis

Are Credit Card Reward Points Taxable?

The answer is apparently maybe.

In the past the IRS has considered credit card reward points to be a rebate on the purchase of a product rather than money earned by use of the card. So, for example, let’s say that you purchased a new computer monitor for $100 on a credit card that gave you 5% cash reward. Your credit card would then give you $5 in rewards points. Rather than claim that your $5 is income, the IRS determined that you should deduct the $5 out of the purchase price for the computer monitor. So now you have a computer monitor worth $95 rather than $100. If for some reason you ever sold that monitor for more than $95, you would owe taxes on the profit. In most cases though, you will never sell it for more than you paid for it, so you will never owe taxes on the monitor.

A physicist named Konstantin Anikeev and his wife Nadezhda Anikeev came up with a brilliant scheme to make money from a generous 5% cash reward plan offered by American Express. Mr. Anikeev is a brilliant physicist who decided to apply his math skills in the matter of his personal finance. Mr. Anikeev got an American Express card with a spending limit above $30,000 as did his wife. He would then go to supermarkets and purchase visa prepaid credit cards or Green Dot and Money Graham prepaid cards. The visa cards could not be converted to cash. They were limited to the purchase of goods. The other prepaid cards however could be used to purchase money orders, which is exactly what the Anikeevs did. They would then take the money orders and deposit them in their bank account to pay the American Express bill. Sometimes they would purchase money orders directly from pharmacies like Rite Aid and earn 5% rewards from American Express for the purchase. They would then do the same thing with the money order and deposit it in their checking account. Mr. Anikeev saw that the purchase of items like Green Dot or money orders cost about 1% of the purchase price. Additionally, when he converted the Green Dot to a money order there would be a fee somewhere between .07% and .33%. So in these transactions Mr. Anikeev was only paying a 1.33% in total fees to convert the purchases made on the American Express card to cash with which he could pay his credit card bill. In the end, Mr. Anikeev earned a 3.67% return on his purchase (5%-.01%-.33%). Going back to our example from earlier, what if Mr. Anikeev purchased a Green Dot card for $100 rather than a computer monitor. He would still earn $5 in reward cash. Green Dot would charge a fee of 1% on the $100 meaning a $1 fee. He would then take the $99 Green Dot card and purchase a money order which charged .33% for the conversion. .33% of $99 is $0.33. So, Mr. Anikeev would have a money order in the amount of $98.67 to deposit in his bank account. He could then pay for the $100 charge on his American Express card with the $98.67. Of course, he would still owe $1.33 to pay off the $100 charge. He would pay that out of the 5% cash reward that he had earned with American Express. So, after paying his American Express bill with the points and the cash from the money order, he would still have $3.67 in cash rewards that he could use for whatever purpose or withdraw as cash. This may seem trivial because of the small numbers, but the Anikeevs had extremely high spending limits. In 2013 the couple spent over $2 million on the scheme. In 2014, the couple spent over $5 million in the scheme. This generated thousands of rewards dollars on the American Express plan.

The IRS had always assumed that credit card rewards would not be treated as income as discussed earlier. This scheme presented a new problem because the Anikeevs were not actually buying goods or services. They were just shuffling the money around in a way to create a profit for themselves. In a ruling released on February 23, 2021, the United States Tax Court determined that the reward dollars generated by the Anikeevs purchase of money orders and Green Dot cards was taxable because the taxpayer did not by goods or services. The Tax Court also determine that the visa cards purchased by the Anikeevs were goods. Because the visa cards had a UPC barcode and could not be used for the purchase of money orders or anything of that nature, the visa cards are actually a good. That means that the purchase of those cards would be treated in the same manner as the computer monitor and was thus untaxable.

So in summary, the points earned on your credit card are generally considered a rebate on the purchase of goods. A rebate is not taxable and therefore your credit card reward points are not taxable. If you choose however, to purchase items such as money orders or other items that can be instantly converted to cash, then your credit card reward points are likely taxable because you are not buying a good or service.

The Tax Court expressed its displeasure with the IRS in their ruling. The Court would like to see rules and regulations published by the IRS that handles a variety of issues that arise from the earning of credit card reward points. There remain numerous questions about the treatment of these reward points based on how they are acquired or how they are used. I expect we will see such rulings from the IRS soon on this matter. It is certainly something that needs clarity. Until that time we will continue to see cases like this, which are fascinating if nothing else. See the link below if you would like to read the case in full.

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