In February, a U.S. Tax Court opinion in Anikeev v. Commisioner addressed challenging issues regarding the IRS’s existing policy with respect to the taxation of credit card rewards and other rebates. The case involves Mr. and Mrs. Anikeev, each of whom held a Blue Cash American Express Card (“Blue Card”) during 2013 and 2014, on which they accumulated a substantial amount of reward dollars through the use of their cards. At issue in Anikeev is whether the reward dollars were taxable income to the Anikeevs. Basing its decision on longstanding IRS policy, the court determined that the overwhelming majority of the rewards were not taxable to the Anikeevs, although the decision does address how the Service could potentially reform its policy regarding credit card rewards to prevent the same result in the future.
The Facts in Anikeev
From 2013 to 2014, American Express paid reward dollars to Blue Card holders who made eligible purchases. Card holders were eligible to receive reward dollars of up to 1% of eligible purchases for the first $6,500 spent in a reward year, and up to 5% for eligible purchases in excess of $6,500. These “reward dollars” could be redeemed for Amazon gift cards or as credits on a card holder’s Blue Card balance. American Express did not impose a limit on the amount of reward dollars cardholders such as the Anikeevs could accumulate in a given year.
During these same years, the Anikeevs each held a Blue Card, which they used primarily to accumulate as many reward points as possible. To achieve this goal, the Anikeevs used their Blue Cards to purchase Visa gift cards, reloadable debit cards, and money orders. In 2013, the Anikeevs charged over $1.2 million for such items, and in 2014, they made charges totaling nearly $5.2 million. It appears that most of these purchases were for Visa gift cards. To maintain credit necessary to continue accumulating points, the Anikeevs would then use their Visa gift cards to purchase money orders, which they used to pay their American Express bills. The Anikeevs also appear to have used reloadable debit cards to pay their American Express bills. On some occasions, they also purchased money orders directly using their Blue Cards.
Through this arrangement, the Anikeevs accumulated significant reward dollars, as well as the ire of the Service. In 2013, they redeemed over $36,000 in reward dollars as statement credits. It appears that 2013 was just a test run because, in 2014, the Anikeevs redeemed over $277,000 in statement credits. The Anikeevs did not report these amounts as income on their 2013 or 2014 federal income tax returns. Thereafter, the IRS issued a notice of deficiency to the Anikeevs, asserting that the full amount of statement credits represented “other” income subject to federal income tax.
Longstanding IRS Precedent on Rewards and Rebates
To fully appreciate the import of the Anikeev decision, it helps to understand existing IRS guidance on the taxability of customer rewards and rebates.
- Frequent Flier Miles. Recognizing the numerous technical and administrative issues inherent in monitoring and taxing frequent flier miles, the IRS has taken the position since 2002, when it published Announcement 2002-18, that it will not pursue a tax enforcement program with respect to promotional benefits such as frequent flier miles attributable to business travel. However, as noted below, the value of an airline ticket obtained through other means, such as the opening of a bank account, should generally be reported as taxable income by the taxpayer who receives this benefit.
- Customer Rebates. The IRS has taken the position that rebates on the purchase of products and services do not constitute income to the customer who receives the rebate. Rather, as set forth in Revenue Ruling 76-96, the rebate acts as a discount on the product or service being purchased. Revenue Ruling 76-96, which the IRS relied upon in litigating its case against the Anikeevs (and was also cited by the court), makes clear that an individual’s basis in such product or service must be reduced by the amount of the rebate received. Note: Rev. Rul. 76-96, 1976-1 C.B. 23 was suspended, in part, through the issuance of Revenue Ruling 2008-26. For example, if a taxpayer purchases a new car for $24K and receives a $2K rebate from the manufacturer, this $2K rebate is not included in the taxpayer’s income. However, the taxpayer’s basis in the vehicle is reduced to $22K because the taxpayer received the $2K rebate. This means that if the taxpayer sells the car for more than $22K, the excess constitutes income to the taxpayer. Alternatively, if the taxpayer uses the car exclusively for business, only $22K is subject to depreciation.
- Bank Accounts. Meanwhile, the IRS takes the position that the value of non-cash gifts received for opening a bank account is reportable as interest income to the taxpayer.
Notwithstanding the Service’s position on frequent flier miles above, this includes the value of an airline ticket redeemed using points earned for opening a bank account. Indeed, in the Tax Court’s decision Shankar v. Commissioner, the court explained that non-cash benefits received for making a deposit into or maintaining a balance in a bank account constitutes interest income. In the court’s words, such benefits constitute “something given in exchange for the use (deposit) of [the taxpayer’s] money; i.e., something in the nature of interest.” Accordingly, a taxpayer must include in gross income the value of any non-cash benefits received in exchange for opening a bank account.
The Positions Taken by the Parties
At trial, the IRS took the position that the Anikeevs did not purchase goods or services for which a rebate or purchase price adjustment could be applied. Rather, the IRS asserted that the Anikeevs purchased cash equivalents in the form of Visa gift cards, reloadable debit cards, and money orders. This is consistent with longstanding IRS policy that treats gift cards as cash equivalents. For example, Treasury Regulations generally prohibit the treatment of gift cards as de minimis fringe benefits on the basis that they are cash equivalents. Technical Advice Memorandum 200437030 applied this prohibition to prevent a $35 gift certificate from being treated as a de minimis fringe benefit because it is a cash equivalent. In American Airlines v. United States, the court held that two $50 vouchers provided to employees to cover meal expenses were not de minimis because they were cash equivalents. Because it viewed the purchases as purchases of cash equivalents, the IRS asserted that the rewards paid to the Anikeevs as statement credits for such charges constitute an accession to wealth and gross income under section 61 of the Internal Revenue Code.
Of note, the Tax Court deemed it important to call out the fact that the IRS initially took an alternative position based upon Revenue Ruling 76-96 that it subsequently withdrew. In particular, the IRS asserted in a pretrial memorandum that the Anikeevs should be taxed on gains arising from their purchase of money orders with Visa gift cards. The IRS theory was that the Anikeevs’ basis in the Visa gift cards should have been reduced by the reward dollars they received on their purchase of the Visa gift cards. Under the IRS’s theory, the Anikeevs would have had taxable gain when they subsequently used the Visa gift cards to purchase the money orders used to pay their American Express bills, since the Visa gift cards would have a reduced basis below the dollar value of the money orders purchased.
The Anikeevs took the position that the rewards generated by their purchase of Visa gift cards that were in-turn used to purchase money orders, are not taxable. The Anikeevs asserted that the manner in which something is purchased is not an accession to wealth. Further, the Anikeevs explained that the Visa gift cards are a product that have a Universal Product Code, and the ultimate use of the Visa gift cards they purchased should not matter. The Anikeevs also recharacterized the IRS’s argument—apparently without objection from the IRS. In their version, the IRS’s position that the Visa gift cards were cash equivalents turned on what the gift cards were used to purchase.
The Tax Court’s Decision in Anikeev
Taking into account the Service’s existing guidance on rewards and rebates, the court’s decision hinged on a relatively straightforward question: were the Visa gift cards, reloadable debit cards, and money orders, purchased by the Anikeevs, property and/or services, as argued by the taxpayers? Or were these items in fact cash equivalents, as argued by the IRS?
Revenue Ruling 76-96 makes clear that rebates provided to taxpayers on the purchase of property and services do not constitute income to the taxpayer, but are instead a reduction in the individual’s basis in the property. Conversely, if the favorable tax treatment set forth in Revenue Ruling 76-96 does not apply, then any amounts received by a customer in connection with the purchase are not excludible from gross income.
Ultimately, the court, considering the nature of the Visa gift cards, determined that they constitute a product subject to favorable tax treatment under Revenue Ruling 76-96. In particular, the court appeared to base its decision on the fact the Visa gift cards were not redeemable for cash or eligible for deposit into a bank account. Accordingly, the court seems to have determined that the Visa gift card were not cash equivalents. The court also held that the fact that the gift cards were used to purchase money orders—themselves, cash equivalents—was irrelevant to the question of whether the gift cards were cash equivalents. Further, the court noted that the Visa gift cards provided an important service to the taxpayers via a product, explaining that “[p]roviding a substitute for a credit card is a service via a product which is commonly sold via displays at drug stores and grocery stores.” In summary, the court concluded that because the Visa gift cards are a product, reward dollars received by the Anikeevs constitute rebates excludible from taxable income.
The Service did notch a small victory in Anikeev. Given the nature of money orders and reloads of cash into debit cards, which the court described as nothing other than “cash transfers,” reward dollars received in connection with the direct purchase of those items did not constitute rebates, and were therefore includible as taxable income to the Anikeevs. As noted above, the record in Anikeev indicates that the majority of reward dollars were generated by the purchase of Visa gift cards, so it appears that the IRS will recoup a relatively small percentage of the taxes it had pursued.
Although the decision was a loss for the Service, the court’s opinion identified how the IRS could approach such arrangements prospectively. In particular, the court states that the Service could have maintained the position taken in its pretrial memorandum that the receipt of reward dollars represented a reduction in the Anikeevs’ basis in the Visa gift cards. Under this approach, which is consistent with the logic of Revenue Ruling 76-96, the court explained that the Service could have asserted that the taxpayers generated proceeds in excess of their basis in the Visa gift cards when they converted the Visa gift cards into money orders. In other words, gain was triggered equal to the delta between the value of the money order and the Anikeevs’ reduced basis in the Visa gift cards (i.e., the dollar value of the gift cards less the rewards dollars received in connection with the purchase of such gift card).
It remains unclear whether the Service will follow the court’s reasoning or whether it will issue guidance indicating its disagreement with the outcome given that it treats Visa gift cards as products rather than as cash equivalents and does not address key aspects of the federal income tax treatment of cash equivalents. The IRS’s loss in Anikeev appears, at least partially, attributable to the decision by IRS counsel to allow the Anikeevs to recharacterize the IRS’s position on gift cards as cash equivalents. The Tax Court’s determination that because the gift cards could not be directly converted to cash meant they were not cash equivalents conflicts with the IRS treatment of gift cards under the fringe benefit rules. For example, even gift cards redeemable for purchases from only one store are viewed as cash equivalents for this purpose. Indeed, the IRS has asserted on audit that gift cards provided to employees for the purchase of goods from the employer cannot be excluded from income on the basis that the gift cards are cash equivalents. If the Tax Court’s characterization of gift cards as “products” is extended to consider them “tangible personal property,” the treatment of gift cards in other contexts could also be called into question and conflict with the definition of such term under section 274(j)(3)(A)(ii). As of the date of publication of this blog post, no action has been taken by either party to appeal the Anikeev decision, although given that parties generally have 90 days to appeal a decision under the rules of the United States Tax Court, the parties will have until May 24, 2021, to file an appeal.