Yesterday, the internet lit up with stories of American Express sending 1099s to people referring credit card referral bonuses. Update: apparently Chase also issued 1099s; the advice remains the same, however. Several other sites touched on the controversy, too, and I’ve read the comments with some amusement. They range from sheer panic on the part of recipients, to outright misinformation on how to address the issue. In this post, I’ll cut through the misinformation and offer some practical tips on what you can do.
Disclaimer: while I am a licensed tax professional, this does not constitute tax advice. Contact your own tax preparer before proceeding with any of these ideas.
Why Are Referral Bonuses Taxable Anyway?
One common point of confusion is why the IRS taxes referral bonuses in the first place. Aren’t frequent flyer miles and rewards points usually nontaxable? Yes, but the issue remains murkier than some have you believe. Some claim the IRS treats points earned on purchases as “rebates”, but that’s not completely accurate. The closest thing the IRS gives you is Announcement 2002-18, where the IRS states:
…Because of these unresolved issues, the IRS has not pursued a tax enforcement program with respect to promotional benefits such as frequent flyer miles. 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.
Tellingly, the Notice doesn’t actually say that points have no taxable value. It just says the IRS chooses not to try and enforce the rules on taxpayers.
Things changed, however, in 2008, when Citi famously sent 1099s for points awarded as a bonus for opening a checking account. (Citi issued 1099s when customers redeemed points, though, not when they received them. That becomes important later.) A disgruntled customer took Citi to Tax Court, but the challenge proved unsuccessful. In Shankar v. Commissioner, the Tax Court ruled that Thank You points awarded solely for opening an account were indeed taxable. That really created a “two tier” system for points bonuses. Bonuses issued based on spend still fall under the old “non-enforcement” policy. But those that require no spend are a different story.
Based on Shankar, referral bonuses have counted as taxable income since 2014. For some reason, American Express just decided to start sending 1099s this year. So if you received one, what can you do? Below I’ll address some of the ideas I’ve seen floating around the internet. Some might work; others, just stay away from them. (For the record, some report receiving 1099s even for total bonuses under $600. If you’re talking about a couple hundred bucks worth, just pay the tax. Just reading this post costs more of your time than the $25 worth of taxes. Seriously. In general, always compare the tax savings to the time and effort involved when deciding how to proceed.)
Fight American Express on the Valuation
Reportedly, Amex assigns a value of $.01/point for Membership Rewards, Delta, SPG, and Marriott points. However, they assign a value of
$.0125/point $.0067/point for Hilton Honors points. (UPDATE: Doctor of Credit provided an updated the Hilton valuation.) You could try calling Amex and ask them to re-issue the 1099 at a lower value. Don’t hold your breath. The company I work for argues with vendors about incorrect 1099s every year; it’s like pulling teeth.
Adjust the Valuation on Your Tax Return
You do have options if you disagree with an amount reported on a 1099, but the vendor refuses to adjust it. Most taxpayers report referral bonuses on Line 21, “Other Income” of Form 1040. (Definitely talk to your tax preparer about proper reporting for your situation.) I always recommend first reporting the gross amount here. Failure to do so guarantees a letter from the IRS later. But, you can “back out” an adjustment to reduce the income to your calculation of proper value. Something like this:
|American Express – credit card referral bonus
|Less valuation adjustment
|Adjusted income to Form 1040, Line 21
If you do this, remember, if audited, you’ll have to justify how you came up with your number. So how can you justify a lower number? Perhaps the program’s own terms & conditions. Amex does, after all, expressly prohibit the sale or barter of points to others. That means the points have no secondary market to establish a valuation. If so, how does Amex justify a valuation when issued? If you can’t “trade” a point, seems to me that no value is established (or at least a lesser one) until the points are used. In tax parlance, we refer to that as the “open transaction doctrine”. Basically, if the consideration (the points) received have no readily ascertainable value, you wait to report income until the value becomes established.
That’s actually where I think Amex got it wrong. Citi at least waits until redemption to issue a 1099. At that point, you know what you received, and can easily assign a value. But the mere issuance of points, which you can’t sell? Held for a speculative future use not known at this time? That seems asinine to me. A word of caution, though: the IRS hates open transactions. Expect an argument in case of an audit.
Or if a zero value feels too aggressive for you, you can just adjust the valuation to something else. For example, reduce the Hilton points value to $.004/point. You might do this by taking screenshots of multiple redemptions that show the fixed value. Whatever you decide, remember that you must provide evidence of your valuation upon audit.
Deduct the Cost of Your Annual Fee
I’ve seen several commenters suggest deducting the cost of the annual fee from the 1099 amount. The idea has a basis in actual tax law – Section 212, which addresses “expenses for production of income”. The section expressly allows a deduction “for the production or collection of income”. If you pay an annual fee on your Amex, and you refer people to the card, that strikes me as a justifiable expense. At least partially; deducting the entire thing presses your luck.
But there’s a problem with this idea. The IRS considers Section 212 expenses “miscellaneous itemized deductions”. And guess what? Those disappeared with the 2018 tax law changes. Simply put: don’t try to deduct your annual fee as an offset to your referral bonus on Line 21. It’s not allowed, and won’t stand up on audit. (Possible exception: you operate a travel business and use the points to review products. Then the fee may qualify as a business expense.)
Amex Owns the Points, so the Points Have No Value to You
A commenter at OMAAT asked how the member has income when Amex’s own T&Cs says the points belong to Amex. Fair question, and I think it goes back to my earlier point about valuing the points. This just seems to further suggest that points have a lesser value when issued. They don’t belong to you, and you can’t sell or barter them. Taken together, I think this makes the strongest argument for using a lower (or even zero) valuation.
Deduct the Eventual Use of Points as an Expense
I’ll give this one extra credit for creativity. I’ve seen some suggest that that if the points generate income when issued, the use should result in an expense. In other words, using 25,000 points for a $400 hotel room means you deduct the $400 when redeemed. I guess I see some logic to that argument. But it only works in the context of business taxes. The reason? The IRS regards all personal expenses as nondeductible. Think about it this way: if you receive a $10,000 cash bonus at work, that’s income. But if you use $5,000 of that to pay for a vacation, you don’t receive a deduction for the expenses.
The only way I see this working is if you redeem points for a business-related expense. Then maybe you can argue for a deduction, since you previously reported the points as income.
What If You Already Filed Your Return?
It seems some who got tagged with 1099s already filed their tax returns. If this describes your situation, don’t panic. You have two options. The technically proper method is to file an amended return. Then, pay any additional tax when you file. Or, some choose to wait until the IRS sends a notice for not reporting the income. Now, an alleged “tax dude” in the Doctor of Credit comments suggests not doing this:
Tax dude here, file an amendment otherwise that 1099 could catch up with your later on with penalties/fines. No statue of limitations for not reporting.
This is only partially true. Failure to report a 1099 can subject you to a special “accuracy-related penalty” of 20%. But that’s usually a function of the magnitude of the error. I once forgot to pick up $155 of dividends on my return; the IRS sent me a bill for like $45 but didn’t charge a penalty. For that matter, in my practice, I’ve not seen small errors generate the penalty. The bigger the number, the more likely they may charge one. Any tax understatement of more than 10% automatically triggers it.
The part about the “statue” (sic) of limitations, though, is false. Forgetting one item of income on a return doesn’t change the standard statute of limitations (three years from filing). Only if the omission exceeds 25% of gross income does the statute extend to six years. The IRS can’t haunt you with a missed 1099 for $600 forever, in other words.
Anyway, if you plan on reporting a lower points value, I advise amending your return. It’s much easier to do so on a return, as opposed to sending the IRS correspondence explaining why you think $600 should actually be $150. (Trust me: it’s hit or miss whether someone actually reads your explanation.) If you don’t plan to do that, assess the risks noted above and decide how to proceed.
Now, if you haven’t filed your tax return yet, I strongly suggest waiting. I can only imagine the volume of hate mail pouring in to Amex right now. It is very possible Amex either corrects the 1099s to report a lower value, or voids them entirely.
What. A. Mess. Amex opened a hornet’s nest here. If you do receive a 1099, hopefully the above tips give you some strategies to mitigate the damage.