You’ve been piling up those credit card rewards and points, maximizing the value of your rewards cards and applying those earnings toward everyday purchases and travel expenditures. The rewards you collected are yours to keep — right? Not so fast. Before you finalize your tax returns, make sure you are following the correct protocol for credit card reward taxes. Unfortunately, the IRS has yet to present any clear-cut instructions on this topic, but it’s important to review your usage of credit card rewards every year and avoid the possibility of an unexpected tax bill. Ultimately, your own personal situation will determine whether you keep those hard-earned rewards to yourself, or if the government is legally entitled to a piece of the pie. Here’s what you need to know about credit card reward taxes —and when you do and don’t have to report them as income.
When to Report
When you take advantage of a credit card’s generous sign-on bonus – such as $200 if you spend $1,000 in the first three months as a cardholder — the IRS considers that income. Here’s why: The IRS deems income to be anything you earned that isn’t directly related to a purchase you made. If instead of receiving cash back, you earned a bonus in the form of points or miles, the same logic would apply. The tricky part is determining the value of the airline miles or points, so you know how much to report as income. Since the actual value of those rewards can vary depending on when and how you use them, you may want to consult a tax professional in this situation to properly calculate the dollar amount of your miles or points bonus.
When Not to Report
The good news is that you do not have to pay credit card reward taxes in most situations. The majority of people collect their credit card rewards by using their plastic over a long period of time. You’re basically spending money and earning a rebate. So if your credit card issuer offers 3 percent cash back on all purchases and you spend $100 in a month, you’d stand to earn $3 back in rewards — which the IRS considers a discount on those purchases, not income. Since you spent money in order to qualify for those rebates, those rewards are yours to keep. If you racked up airline miles or rewards points instead of cash back, the same situation applies. The IRS deems those rewards as a version of a discount, and they don’t fall under the taxable category as defined by federal government standards.
Check Your Credit Card Agreement
Some credit card issuers have begun disclosing in the cardholder agreement that they may report credit card rewards to the IRS if they meet a certain threshold, generally $600. If you’re concerned about credit card reward taxes, check your credit card agreement to find out if your issuer might be among those that report to the IRS. Still, unless you fall in the sign-on bonus bracket, your credit card rewards likely wouldn’t be reportable.
You need to be a little more cautious when you’re using a rewards credit card for work-related expenses that you plan to deduct as business expenses. If, for example, you make a $750 purchase and earn 2 percent cash back, you are only allowed to deduct the actual amount you paid, including the cash-back “discount” — which would be $735.
Got a 1099?
While it’s rare to receive a 1099 from a credit card company, it’s entirely possible that you could if you earned more than $600 for a sign-on bonus. In that case, make sure you do report the credit card reward taxes that are subject to the 1099. If you simply toss the 1099, you could end up with a hefty tax bill and penalty. And if you earned less than $600 over the course of a year in the form of sign-on bonuses, you won’t receive a 1099 — but tax experts advise you to report the amount anyway. Your best bet: If you earned a sign-on bonus, report it as miscellaneous income. You’re better off erring on the side of caution where the IRS is concerned.
Here’s More Help
It can be tricky trying to decode the mysteries of credit card reward taxes, but don’t let credit card rewards add to your stress at tax time. For more guidance, browse through the rest of our blog posts in our Education section. Then let us know how we can help you brighten your credit outlook with a free consultation here at Ovation Credit.