Cash back rebates are among the most popular of features of U.S. credit cards. According to a March 2009 study by TNS, the percentage of U.S. cardholders with cash back cards rose from 57 percent to 61 percent between 2007 to 2008, and TNS forecasts the percentage to gradually increase at least until 2010. Some cardholders naturally wonder whether the income from these rebates needs to be disclosed on their tax return.
There is no definitive ruling from the IRS on the subject, but several things suggest the IRS would not consider cash back taxable income.
1. The 2002 IRS Private Letter Ruling on Credit Card Rebates
In 2002, the IRS was asked for a private letter ruling about a credit card program in which the cardholder could elect to either receive rebates personally, or direct them to a charity. The IRS concluded that in either case, the rebates were essentially a reduction in the purchase price of the items bought with the card with after-tax dollars, and thus would not be income. In previous cases, the IRS had ruled that a rebate received directly from a merchant is the equivalent of a reduction in the purchase price, not income. See PLR-145990-01.
What is a private letter ruling?
A private letter ruling is a written opinon issued by the IRS in response to a request from a taxpayer or their tax adviser. It only applies to the specific taxpayer in question. It cannot be used as legal precedent by other taxpayers or by the IRS. Nonetheless, private letter rulings are useful as indications of how the IRS views a particular tax issue.
2. What About Credit Card Rebates on Business or Investment Purchases?
A more difficult question is whether the IRS would treat as income rebates on credit card purchases made for business or investment purposes. The IRS may take a different view of these if the taxpayer is deducting the purchases as an expense on their return. Many credit card agreements prohibit such purchases, however.
A 2002 announcement by the IRS suggests that if a cardholder is deducting travel expenses on their return but receiving cash rebates on the travel purchases, the rebates could be taxable. The IRS was addressing frequent flier miles received by taxpayers for flying on "business or official travel." The agency announced that it would not treat the miles as taxable, but explicitly reserved ruling where the travel rebate was in the form of cash:
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.
The relief provided by this announcement 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.
3. Why Aren't Frequent Flier Miles Rewards Taxable?As discussed just above, the IRS announced in 2002 that it would not go after a taxpayer for leaving frequent flier miles off their tax returns as income. This is generally viewed as a reflection of the practical problems involved with quantifying the value of these miles and the relatively small sums often involved. In other words, the lost tax revenue just was not worth the trouble involved. The agency wasn't saying these miles rewards are not income, but rather that it would look the other way.