One of the most popular ways the credit card companies compete with each other is by offering rewards programswith their cards. The card issuers know that people are more likely to be loyal to a company if they have a reason to consistently use the card. This is why there are a seemingly limitless number of credit card rewards programs including cash back, points, travel, airline rewards, gas rewards, etc. The more frequently you use your credit card, the more likely the credit card company will make money from you. (But if you pay your balance in full each month, using a rewards card can be a savvy financial move which puts hundreds or even thousands of dollars back in your pocket each year).
Another popular way credit card companies gain new customers is by offering sign up bonuses to new cardholders. Some of these can be worth several hundred dollars or more, which is a nice return just for opening a new credit card.
But all of these rewards bring up an interesting dilemma – are these rewards or sign up bonuses considered taxable income?
The answer is – it depends.
Sign Up Bonuses Are Often Taxable
Many sign up bonuses are considered taxable income, especially when they are offered by banks, brokerages, and other financial instituions. I have opened several bank accounts for the sign up bonus, and each time I received a 1099-INT at the end of the year. In each instance, the banks reported the bonuses as earned interest, which is taxed as ordinary income – meaning you pay your standard income tax rate on the bonus.
Sign up bonuses for brokerage accounts can be different, depending on which type of account you open. If you open a standard trading account, the income will likely be reported in a similar fashion as the banks. However, if you open an IRA, your bonus may be deposited in your IRA, so it may receive the same tax treatment as your investments in your account.
If you receive a 1099-INT, you know what to do – report it on your taxes and pay the tax man. But if you don’t know how it should be classified, then it’s best to check with the brokerage firm or your accountant for verification before filing your taxes.
What about Cash Rewards and Frequent Flyer Miles?
I know you’re just going to love this answer – again, it depends. In almost all cases, your credit card rewards will be classified as a rebate, which the IRS has gone on record as stating isn’t considered as taxable income (see private letter ruling from 2002, and Announcement 2002-18 for more information).
The IRS considers rebates the same as a discount, you just get it after the fact. So earning cash back or frequent flyer miles from a purchase is essentially the same thing as using a coupon with your purchase. The IRS also doesn’t consider frequent flyer miles earned from flights as taxable income.
Are Credit Card Sign Up Bonuses Taxable?
If the credit card company is offering you a bonus just to open a new credit card, then it’s possible the bonus could be considered income by the IRS. The key is determining how the bonus was earned. If there is no requirement other than to open an account, then it is similar to the bank example above, and you may owe taxes on the income. This was the case last year when Citi sent out 1099s to new customers who received 25,000 bonus miles for opening a new account. Citi valued the bonus miles at $0.025 per mile, which gave the bonus a dollar value of $625, above the $600 threshold the IRS sets for requiring a 1099 for prizes and rewards.
But that doesn’t mean all sign up bonuses are taxable. Most credit card companies, for example, require new cardholders to spend a minimum amount of money in set time frame in order to receive the bonus. A common example is a $100 cash bonus which only kicks in after the new card holder spends $1,000 within the first three months. Some credit card bonuses are also tiered, for example, you may receive a certain cash bonus or number of frequent flyer miles for spending $1,000 in a certain time limit, and you may receive another bonus when your spending level reaches $5,000. If there is a spending requirement to receive the bonus, then it is considered a rebate, not income.
Play it Safe
Credit card rewards and sign up bonuses are a gray area. The IRS private letter ruling and announcement above are considered more like guidelines, not hard and fast rules. My rule of thumb would be to always report the income if you receive a 1099-INT – that’s a no-brainer, since it is the law. If you receive any other bonuses, then I would use the rebate test. Did you have to meet a certain spending requirement to receive the bonus? If so, then it is probably a rebate, and therefore, probably not taxable. As always, it never hurts to double check with a tax professional if you have doubts or further questions.