As the old saying goes, there’s no guarantees in life but death and taxes. And while you will eventually experience both of those things, thankfully they will not be the result of all of your actions. For example, the rewards you earn from your credit cards are generally not tax deductible.
Here’s how cash back credit card rewards escape taxation.
The credit card industry is extremely competitive, and card issuers will offer generous amounts of points, miles or cash back in order to win new customers and retain them. This level of competition extends beyond the market for consumer cards and into the market for business credit cards. When cardholders receive these rewards, it can feel like they are earning something that has taxable value.
However, cash back credit card rewards don’t represent income, and are not taxed. For example, if you spent $10,000 on your business credit card that offers 2% cash back, then you’ll receive $200. Even though this $200 may be received as a direct deposit in your bank account, or even as a check, it still isn’t considered income. Because you had to spend $10,000 to earn the $200 in cash back, you are actually receiving a discount on a purchase, and have a net expense of $9,800. It’s just like when you use a coupon to save money on a purchase. The value of the coupon won’t be taxable since you have net income gain.
The exception is when you receive rewards that are greater than your expenditures. For instance, if a bank offers you a $500 bonus for opening a new account, then you won’t have any expenses associated with the receipt of that income. Even the amount that you deposit is not an expense, since you retain ownership of it and can withdraw it at any time. Therefore, most banks will issue a 1099-MISC form to customers who receive these bonuses for opening a new account. However, when you receive credit card rewards, it’s in return for spending that exceeds the amount of the reward. When this happens, there’s no taxable income, only a net expense.
But what about frequent flyer miles and other travel rewards?
As frequent flyer programs became more popular, accountants and tax preparers were unsure how to treat these valuable rewards. In response, the IRS issued a document in 2002 called, Announcement 2002-18, Frequent Flyer Miles Attributable to Business or Official Travel. This one-page memo clarified its stance on the taxability of points and miles earned from airlines, hotels and rental car companies. It says:
Consistent with prior practice, the IRS will not assert that any taxpayer has understated his federal tax liability by reason of the receipt or personal use of frequent flyer miles or other in-kind promotional benefits attributable to the taxpayer’s business or official travel. Any future guidance on the taxability of these benefits will be applied prospectively.
In plain English, the IRS is saying in this announcement that they just aren’t going to bother trying to account for all sorts of travel rewards earned as points and miles, figure out their value, and ask businesses and taxpayers to include it in their returns. The IRS seems to be admitting that the tax code complicated enough without having to digest the nuances of every airline, hotel and rental car loyalty program. And if it changes it’s mind at some future date, it will let us know and it won’t apply the new ruling to our old returns.
There are tax implications for using travel rewards for business.
Just because you won’t get taxed on the value of your credit card rewards, it doesn’t mean that there aren’t any business tax implications for using them. When you purchase travel reservations for business trips, you can deduct their cost as a business expense. But since points and miles have no taxable value, you won’t be able to deduct anything when you redeem your rewards for a business trip. Therefore, small business owners with limited rewards might consider saving their points and miles to redeem them for non-deductible personal travel, while purchasing their business travel reservations in order to claim the deduction.
Here’s the bottom line.
It should come as a relief to business owners and tax preparers alike that the IRS doesn’t consider business or personal credit card rewards to be taxable, yet you do have to contend with the fact their use isn’t tax deductible either. So feel free to earn as much rewards as possible from your business credit cards, without worrying about getting a tax bill later.
This article was originally written on November 27, 2017 and updated on February 2, 2021.