When are credit card rewards taxable? What you need to know

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Earning a few percentage points in credit card rewards on your spending may not seem like a big deal, but it adds up quickly. Whether you earn a few hundred bucks in rewards each year or earn thousands of dollars in free travel regularly, you may be wondering if there are any tax consequences to know about.

Good news: according to the Internal Revenue Service (IRS), credit card points, miles, and cash back aren't taxable in most cases. However, there are some exceptions you should be aware of. 
 

Understanding credit card rewards

Before we tackle the tax implications, let's break down the types of credit card rewards you might be earning:

1. Cash back: The most straightforward reward — you get money back on your purchases. It's usually a percentage of what you spend, like 1.5% or 2% on all purchases, or higher percentages in specific categories.
2. Points: Flexible rewards you can redeem for travel, merchandise, or sometimes cash. Points systems can vary widely between card issuers, with some offering more value when redeemed for travel.
3. Miles: Typically used for travel, especially with airline-branded cards. Airlines often tie these to their specific loyalty programs, but some allow you to use them across airline alliances.

Some cards offer the same rewards rate on all purchases, while others give bonus points in specific categories. For example, you might earn extra points at restaurants or gas stations. This is where strategic spending can boost your rewards earnings.

How can you use these rewards?

• Cash back: Statement credits, cash deposited to your bank account, gift cards, or even travel bookings through the card issuer's portal.
• Flexible points: Travel bookings, transfers to airline or hotel partners (often the most valuable option for travelers), cash back, gift cards, or merchandise.
• Hotel points: Free nights, room upgrades, or other perks with specific hotel chains.
• Miles: Flights (including premium cabins for long-haul travel), seat upgrades, or covering fees like checked baggage.

The key to maximizing your rewards is understanding your spending habits and choosing a card (or combination of cards) that aligns with where you spend the most money. For some, a simple cash back card might be best. For others, a travel rewards card with transferable points could offer more value, especially if you're comfortable with more complex redemption strategies.

General tax rules for credit card rewards

The IRS sees most credit card rewards as rebates rather than income. That's why you don't have to report them on your tax return. This rule applies whether you're earning cash back, points, or miles. A 2024 IRS memorandum explains:

"A rebate is generally a return of an amount actually paid by a customer in a sale. Under credit card reward programs, the cardholder receives cash back or other rewards from making purchases with the credit card in an amount determined by the purchase price."

This means the IRS doesn't consider taxable income taxable income if you're getting 2% cash back on your groceries or redeeming 100,000 points for a first-class flight to Paris. Even credit card sign-up bonuses aren't taxable if you have to spend money to earn them.

The logic behind this is that you're not really "earning" anything new — you're getting a discount on purchases you've already made. It's similar to using a coupon or shopping during a sale.

When credit card rewards may be taxable

While most rewards fly under the IRS radar, there are a few situations where you might owe taxes:

1. No-strings-attached bonuses: If you get rewards without having to make any purchases, it could be considered taxable income.
2. Referral bonuses: Earning rewards for referring a friend to a credit card might be taxable.
3. Bank account bonuses: While not technically credit card rewards, bonuses for opening a new checking or savings account are usually taxable.

Tax attorney and certified public accountant Chad Cummings explains: "This is because these types of rewards do not reduce the cost of a specific purchase and could be viewed as an incentive provided by the financial institution rather than a discount or rebate."

Reporting your credit card rewards on tax returns

If you end up with $600 or more taxable rewards, you'll likely receive a Form 1099-MISC from the bank or credit card company. You’ll need to report this income when you file your tax return.

Cummings warns: "Failure to do so can yield penalties and interest for underpayment." Even if you don't receive a 1099-MISC, you're still responsible for keeping accurate records and reporting taxable bonuses.

Credit card rewards for businesses

Things get trickier for small business owners using rewards credit cards. For example, you can't double-dip on tax deductions if you redeem rewards for airfare or hotel stays on a business trip.

Cummings clarifies: "If a business earns rewards like cash back or points and uses these rewards for business purposes, the value of these rewards should reduce the amount of deductible business expenses."

In other words, if you use rewards points to book a $1,000 business flight, you can't then deduct that $1,000 as a business expense on your taxes. The rewards essentially lowered your out-of-pocket cost.

Tips for managing credit card rewards and taxes

You can make the most of your rewards with these strategies:

• Keep track of bank bonuses and taxable rewards you earn. Remember that you’re required to self-report even if you don't receive a Form 1099-MISC from the bank or financial institution.
• Consider redeeming business card rewards for personal use to avoid complicating your business expense deductions.
• Consult with a tax professional if you're unsure about the tax implications of a specific reward or bonus.

Recent developments

There's been some chatter about potential changes to credit card rewards programs. The Credit Card Competition Act, introduced in 2022, aims to reduce swipe fees for retailers and other companies that accept credit cards as payment. Some worry this could impact generous rewards programs, but others argue card issuers can still make them work.

While this legislation doesn't directly address the taxation of rewards, it's worth monitoring as it could impact the overall landscape of credit card rewards.

The good news? There's currently no legislation specifically targeting the taxation of credit card rewards. For now, the IRS seems content to let most credit card rewards remain tax-free in 2024. But as always, in the world of taxes and finance, it's wise to stay informed about potential changes.

The bottom line

Credit card rewards usually offer great perks without triggering a tax bill. Whether you're earning cash back, points, or miles through spending, you're generally in the clear with the IRS.

However, stay alert for potentially taxable situations and always report any taxable bonuses, even without a 1099-MISC. By understanding these rules and staying informed about potential legislative changes, you can maximize your rewards while remaining compliant with tax laws.

Editorial disclosure: Opinions expressed are author's alone, not those of any bank, credit card issuer, or other entity. This content has not been reviewed, approved, or otherwise endorsed by any of the entities included in the post.