Banks and credit card companies spend millions of dollars each year on cash back, rewards points, and travel miles. In 2017, for example, American Express, Capital One, and Discover doled out a combined $12.9 billion in rewards payments!
That’s obviously a huge number, and one that’s increasing over time as banks and credit card companies offer more enticing benefits to businesses and consumers. 67% of small business owners use a business credit card, and most of them earn rewards on purchases.
Although most people think of credit and deposit account rewards as free perks, they’re not “free” in all cases. Depending on how you earn them, rewards points, cash back, and travel miles could constitute taxable income. There are some situations where you have to report these benefits on your taxes—and failure to do so can land you in hot water with the IRS.
Understanding tax regulations can be difficult for even the savviest of small business owners, so we’re going to break things down for you. Find out when rewards can constitute taxable income and how to report these on your personal or business tax return.
Rewards Related to Spending Are Tax-Free
The most common types of rewards points, cash back, and miles go hand in hand with spending. For example, you can earn points by charging certain kinds of purchases—like travel, dining, or online purchases—to your business credit card. Or, you can earn points by reaching a spending target on your card—for example, spending $5,000 on the card within three months of opening the account.
The IRS’s position is that these transaction-related benefits are “rebates” or “discounts,” not taxable income. The IRS first came to this conclusion in a 2002 memorandum and later confirmed this reasoning in a 2010 memorandum.
Here’s what the IRS had to say in the later memo:
“Taxpayers will make purchases with the credit cards, and as a result of those purchases, will be entitled to receive rebates…. The portion of the credit card purchases that taxpayers can… receive back in cash… does not constitute gross income to taxpayers.”
The key to whether a reward is a rebate or discount, rather than taxable income, is whether a transaction is involved. Credit and debit card companies generally give you cash back when you make a purchase with the card. For instance, you might 3% back on restaurant purchases, 2% back on business supplies, 1% back on other purchases, etc. In addition, card companies sometimes offer a points bonus if you surpass a certain spending threshold within a specific window of time—like 20,000 bonus points after you spend $1,000 in the first three months of account opening.
In these cases, since a transaction is involved—you actually have to spend something on the card to earn the reward—the IRS doesn’t consider the rewards as taxable income. Even if you earn rewards points from business spending and later use those rewards for personal reasons, the IRS won’t tax you on those points. The IRS looks at points earned through spending as a rebate—you’re buying something, and the credit or debit card company later gives you a discount off the purchase.
Due to the difficulty of tracking point redemption and assigning a dollar value to rewards points, the IRS is unlikely to change their view anytime soon. That said, you should always consult a tax professional on anything tax related. If you’re ever in doubt about whether income is taxable, check with a pro.
…But Rewards Can Limit Your Business’s Tax Deductions
As a small business owner, you’re probably already aware that you’re eligible to claim tax deductions for eligible business expenses. Cash back and rewards points, although not directly taxable in most cases, do lower your tax deductions—and that indirectly increases your tax bill. You have to reduce deductions on business expenses by the value of any cash back or reward points that you receive.
For example, say you charged some supplies to your business credit card totaling $1,000. If the card issuer gives you 2 points for each dollar spent on supplies, you’ll earn 2,000 points for the purchase. If each point is worth 1 cent, then you received a “rebate” of $20 on the supplies purchase. That technically means, when filing your business tax return, you can’t deduct $1,000 for that expense—you can only deduct $980.
To be in the clear, check your credit card statements regularly, and enlist the help of your accountant to keep track of rewards, cash back, and miles that you earn.
Loyalty Points Are Also Generally Tax-Free
Sometimes, a credit card or bank account might not even be in the picture. Airlines, hotels, and rental car companies have their own loyalty programs. For a small cost or for free, you can earn loyalty points by using their services. For example, every time you book travel using a travel platform like Expedia, you can earn points that can be used to pay for future travel.
The IRS treats these points in the same way as spending-related rewards. Since you earn the rewards through a transaction—like buying a flight or booking a hotel stay—the IRS doesn’t consider loyalty points as taxable income.
→TL;DR (Too Long; Didn’t Read): Credit and debit card rewards points are typically tax-free if you have to spend something to earn the reward. However, rewards can lower business tax deductions and thereby increase your tax bill.
Bank Account Sign-up and Referral Bonuses Are Taxable Income
From a tax standpoint, things get more complicated when you earn rewards, cash back, or miles without having to spend anything in return.
- Referral bonus that goes into your savings or checking account for referring a friend to a bank.
- Sign-up bonus for opening a savings or checking account (without any spending requirement on a connected debit card)
- Bonus for maintaining a certain balance in your account or for enrolling in direct deposit.
In these situations, says Jane Spradlin, a CPA and business consultant at Concannon Miller, the bonuses constitute taxable income. Since the bank isn’t requiring you to spend anything to earn the reward, that makes the reward similar to taxable interest income or gift income, rather than a rebate/discount.
Depending on how the bank categorizes the income (that’s an internal decision), you might receive a 1099-MISC or a 1099-INT form to report the income to the IRS. Spradlin says that if the reward is more than $10 (if categorized as interest) or $600 (if categorized as miscellaneous income), you should receive a 1099.
If you receive these forms from a bank, you definitely shouldn’t ignore them and must report the income on your tax return. If you have a disregarded business entity (such as a sole proprietorship), you would report miscellaneous business income on Schedule C and interest income on Form 1040. For incorporated business entities (such as LLCs and corporations), you would report both types of income on your business tax return.
Even if you don’t receive a 1099, you’re responsible for reporting all sources of income to the IRS. And don’t forget that states and localities have their own tax reporting requirements. We suggest hiring an accountant to keep track of your sign-up and referral bonuses so that you can be in the clear with all tax agencies.
Citibank Example of Taxable Rewards
In 2011, Citibank offered customers who had an American Airlines travel miles credit card a bonus of 25,000 to 50,000 airline miles as an incentive for opening a deposit account. The following year, the bank sent 1099-MISC notices to these customers which showed the estimated dollar value of the miles.
Customers were surprised to receive these notices for what they thought was a perk, not taxable income. One couple even sued Citibank in Federal Tax Court, but the Court sided with Citi, saying,
“We proceed on the assumption that we are dealing here with a premium for making a deposit into, or maintaining a balance in, a bank account. In other words, something given in exchange for the use (deposit) of Mr. Shankar’s money; i.e., something in the nature of interest. In general, the receipt of interest constitutes the receipt of an item of gross income.”
Following the Citi case, banks have become more careful about issuing 1099s after providing customer rewards. If you receive one, make sure you report the income on your tax return.
Disputing the Estimated Point Value
Citibank received a lot of customer blowback when they sent out the 1099s, in part because of how they estimated the value of the airline miles that they had awarded to customers. Citi valued each mile at 2.5 cents each, so some customers received 1099s for as much as $1,250. Most rewards points, however, are only worth between 1 to 1.5 cents each.
If you receive a 1099 notice from a bank and disagree with the dollar value that the bank has attributed to the points, there’s a dispute process. As an initial step, you can contact the bank and ask them to change their calculation and issue you a new 1099. If that doesn’t work, you can also file a dispute through the IRS.
→TL;DR: When a bank offers a sign-up bonus or referral bonus, without requiring you to spend anything to earn the reward, the bonus counts as taxable income. You might receive a 1099 form to report the income on your tax return.
How to Maximize Rewards on Your Business Credit or Debit Card
The bottom line is that rewards points aren’t taxable as long as a transaction is involved. That means the rewards we all love racking up—when we travel or dine out or make specific types of purchases—are tax-free. These rewards are basically discounts—money that goes back into your pocket and that you can reinvest in your business.
Here are some ideas for maximizing business rewards:
Get a Card That Reflects Your Most Frequent Spending Categories
The first and most important step is to get a business credit card that reflects your biggest areas of spending. Some cards prioritize business travel, some prioritize online spend, and others prioritize inventory and supply spend.
Rewards are basically free money, so you want to ensure that the card you are getting is suited for your type of business. For example, getting a card that offers 3x points on restaurant purchases when you don’t dine out with clients is a wasted opportunity. In some cases, getting two cards is beneficial, so you can split their usage based on the type of purchase.
The Capital One Spark Cash Select for Business is a good, all around credit card that works for most types of small businesses. You can earn a flat 1.5% cash back on every purchase, without limit and with no annual fee.
Make Sure You Will Earn Enough Rewards to Counteract any Annual Fee
Many business credit cards come with an annual fee. You should make sure that the points or cash back that you’ll earn on the card more than make up for the fee you’ll have to pay.
Review your business’s spending history, and estimate your costs and spending categories for the coming year. If the rewards you’ll earn are higher than the annual fee, you should probably get the card. Also, remember that most business credit cards offer other value-added services that can save you money—such as rental car insurance and trip cancellation insurance.
The American Express Business Platinum Card has a whopping $595 annual fee, but offers airline credits and discounts worth nearly $1,250. This is certainly a case where the rewards can more than account for the fee.
Redeem Your Points Wisely
The way in which you redeem credit card rewards also matters. Some credit card companies will give you additional benefits if you redeem rewards for specific uses or on the company’s internal shopping portal.
For example, Chase offers a huge sign-up points bonus on the Ink Business Preferred Card. The bonus is worth 25% more if you book travel using Chase’s Ultimate Rewards portal, rather than an external travel site.
Find a Card With 0% Introductory APR
Finding a card that offers rewards points and a 0% introductory interest rate is a win-win situation. Not only do you get benefits from spending on the card, but you also don’t have to pay interest on those purchases until the introductory period is over. You’re essentially able to borrow money for free during the 0% APR period.
Credit card APRs normally range from around 13% to 21%, so the interest can really add up when you carry a balance from month to month. That can eat up the value of any rewards you might have earned. Using a card with a 0% introductory APR helps you maximize your rewards-earning potential.
The Amex Blue Business Plus Charge Card offers a 12-month 0% introductory APR period. After these 12 months, your APR will set in at a rate that will vary with the market and your creditworthiness, so be sure to see the issuer’s terms and conditions for the latest APR information.
→TL;DR: Since spending-related credit card rewards are tax-free, you should try to maximize rewards. Get the right card for your business, and make sure that the rewards you’ll be earning make up for any annual fee and interest payments.
Bottom Line: Most, But Not All, Rewards Points Are Tax-Free
You can rest easy knowing that you probably don’t owe the IRS any money for points or cash back that you’ve earned from a business credit card. As long as you had to spend something to earn the reward, you’re in the clear.
But make sure you follow these pointers:
- When you have to purchase something to earn rewards points, cash back, or miles, the IRS considers that a rebate, not taxable income.
- Bank account sign-up bonuses and referral bonuses are taxable interest income or miscellaneous income. In these cases, the bank might send you a 1099 notice to report the income on your tax return.
- Even if you don’t receive a 1099 form, you’re responsible for correctly reporting your business’s income on your taxes.
- Since most rewards are free, you should maximize them! Get a business credit card that’s right for your business. And make sure you’ll earn enough points to cover any fee or interest that you might have to pay.
Rewards are tax-free benefits in most cases, so take advantage and make sure you’re getting back as much as possible for your small business.