The IRS Doesn’t Care if You Buy Gift Cards With Rewards Points

IRS gift taxes

With the holidays in full swing, we are all looking for a way to reduce our holiday spending and make this the holiday we really don’t go overboard, spend more than we want to and really get crazy on our holiday shopping (yeah, right). This time of year is often a burden on families struggling already, and those are often families looking for a way to reduce the cost of their holiday spending so that they can still provide gifts for their loved ones without sacrificing their grocery or gas money. There are many ways that these families might make the holidays possible; getting a second job for a few months during the holiday season, selling items they already have or even cashing in on rewards points they might have been accumulating for several years now.

In all honesty, many people use their miles, points and cash back rewards this time of year whether they struggle financially or not. It’s a great concept; you have a cash back credit card that offers you 2% cash back on all your purchases and you have spent $50,000 on that card this year, you’re getting $1,000 back; and many people choose to redeem those points this time of year so that they can make their Christmas shopping a little more affordable.

There is not a thing wrong with that; we love it.

However, there is a little issue with the Internal Revenue Service (IRS). They aren’t always so forgiving of free items. I mean, you win money on the lottery or a game or a casino and they want their cut of that; so it only makes sense that they would tax you on your free points, miles and cash back, right? It’s income, and the IRS uses any means possible to get a portion of your income in their pocket. It’s what they do; it’s for ‘the people,’ and it’s for the country. So, does the IRS tax shoppers when they cash in their free points/rewards/miles or cash back?

Rewards from Credit Cards are Not Taxable

Rest assured holiday shoppers; your rewards are not taxable. You can cash in as many miles or points or cash back deals as you want and keep them just for yourself. The rules set by the IRS are very clear in terms of credit card reward points; at least in terms of airline miles. For many years, the IRS has considered airline miles a rebate rather than a form of income. This is how they justify the fact that they do  not charge any taxes for these items. In fact, it seems as if they view your rewards as a coupon or a discount rather than actual income. The exact terminology used by the IRS to discuss their views on rewards points issued by credit card companies is long and drawn out, confusing and as boring as you might imagine; which is why we decided to explain it in layman’s terms – no tax on credit card reward points.

Let’s look at it this way: You go shopping and you decide you want to buy a trip to Hawaii so you use your credit card to book two flights and a hotel and your credit card company said, “Hey! Good for you! Since you are treating yourself to a fun trip and you deserve it since you have four kids and you’re so busy all the time, we’re going to throw in a free flight to anywhere you want anytime you want to take it in the next few years to say thanks for booking your amazing trip through us,” and called it a day. You don’t pay for that because the company decided they wanted to give it to you, and that means you don’t have to pay taxes on it. Pretty simple, right?

What about Business Rewards?

All right, so the IRS is not taxing us on something. Clearly, that means that there must be some sort of other stipulation being dealt with on behalf of the IRS to make up for the loss of potential income they  might have earned by taxing us on our free rewards, right? Nope; not even the case. Even business rewards and points are free of charge, and that makes for a really nice bonus for all people who want to shop and enjoy their rewards without spending actual cash this holiday season.

“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 attributed to the taxpayer’s business or official travel,” is what IRS announcement 2008-18 reads. That’s all we need to know about that.

Exceptions to the Rules

Like anything else that we do in life, there are exceptions to any rule. This particular rule comes with a number of exceptions, but they are very rare and usually not something that you have to worry about encountering in your own financial life. For example, if your employer decides that the free nights they used for you to extend your business trip a night or two to enjoy a different city are considered compensation to you, they might list that on your W-2 form as miscellaneous income. If that is the case, then you are required to pay the taxes on this income. However, this very rarely happens.

Additionally, some banks will not mention to you in any big print (usually the finest of the fine print only) that if they provide you with cash back for opening a new bank account with them (as many banks do these days), they will issue you a 1099 form that states that this income was received by you. Now, not all banks do this – but some do. If you receive a payment from a bank after opening a new account and then you receive a 1099 listing it as earned income, you have to pay the taxes on that. Otherwise, you are good to go spend your rewards points from your personal or business card however you would like to buy whatever you want for yourself or your loved ones.

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