Are frequent flyer miles taxable?

BY ALISTAIR M. NEVIUS

Earlier this year, Citibank surprised many of its customers by issuing Forms 1099-MISC, Miscellaneous Income, to report the value of frequent flyer miles the customers had received in exchange for opening new accounts as part of an ongoing promotion. Understandably, the customers were upset because, the value of the miles notwithstanding, many of them ended up paying dearly (through potentially as much as several hundred dollars in taxes) merely for opening an account.
 
Two customers have filed a federal lawsuit seeking class action certification (Hirsch v. Citibank, N.A., No. 1:12-cv-01124 (S.D.N.Y., filed 2/14/12)), and Sen. Sherrod Brown, D-Ohio, wrote Citibank to reprimand it and ask it to discontinue the practice.
 
This seemingly should be a cut-and-dried matter, but the Code and the regulations do not address the taxability of frequent flyer miles. Announcement 2002-18 specifically addresses frequent flyer miles, but it does not provide much guidance. Instead, it merely indicates the IRS does not plan to pursue enforcement: “[T]he 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.” In addition, the announcement deals only with frequent flyer miles a taxpayer earns from business or official travel, not with frequent flyer miles given to a taxpayer as part of a product promotion. The IRS has seemed willing at times to give taxpayers a pass on certain items that are relatively modest in amount, involve subjective estimates of value, and are difficult to enforce.
 
With this announcement in place, why did Citibank file Forms 1099 to report the miles as income? The law is vague at best, and the instructions to Form 1099-MISC call for reporting of “prizes and awards” as income.
 
While conservative, Citibank’s approach may not be unreasonable under the circumstances. Penalties for nonfilers of Forms 1099 were recently increased to as much as $100 per form, up to $1.5 million per calendar year for inadvertent omissions (and, presumably, Citibank files many of them). For intentional disregard, penalties equal $250 per form, and there is no cap on the penalty. Finally, the IRS has made no secret of its intention to increase scrutiny in this area. Most 2011 business tax returns include new questions asking whether Forms 1099 are required and whether they have been, or will be, filed.

For a detailed discussion of the issues in this area, see “Taxation of Frequent Flyer Miles,” by Stanley E. Rose, CPA, in the August 2012 issue of The Tax Adviser.

Alistair M. Nevius, editor-in-chief
The Tax Adviser

Also look for articles on the following topics in the August 2012 issue of The Tax Adviser:

  • Results of our annual tax software survey.
  • A discussion of converting from C to S status or an LLC.
  • A look at the final regulations under Sec. 2036.

The Tax Adviser is the AICPA’s monthly journal of tax planning, trends, and techniques. AICPA members can subscribe to The Tax Adviser for a discounted price of $85 per year. Tax Section members can subscribe for a discounted price of $30 per year. Call 800-513-3037 or email taxsection@aicpa.org for a subscription to the magazine or to become a member of the Tax Section.

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