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You’ve just earned a ton of bonus points by spending $3,000 within 3 months after signing up for a new rewards credit card. What will you redeem your points on – a new mp3 player, a bunch of movies, taxes or some clothes? Wait, did I just say taxes?
You may not have thought about paying taxes on your credit card rewards, but Uncle Sam surely has. After all, it could be another opportunity for him to reach into your pockets!
So, will Uncle Sam have his hand out for a chunk of your rewards or will you keep what you’ve earned? Let’s take a look.
Taxes on Purchase Rewards
Although various reports have indicated that Citi has sent out 1099 tax forms to some of it’s customers, that may have been overkill. Most other credit card issuers do not bother sending out such forms, leaving it up to their customers to decide the tax implications of their rewards.
Just because an issuer doesn’t send out tax documents doesn’t mean that the rewards are not taxable. However, the IRS doesn’t consider frequent flyer miles, points or other rewards that have been earned as a result of purchases to be taxable.
So, those 3 miles per dollar that you earn on airline purchases or those 2 points per dollar spent on groceries won’t be taxable. The rewards are considered a reimbursement of your fees, not income.
Taxes on Sign-Up Bonuses
Alright, what about sign-up bonuses?
If a bonus is earned purely by signing up for a credit card, then it is taxable. So it could be argued that there is a benefit to signing up for credit cards with a sign up bonus that requires some initial spending.
This is because the bonus is not taxable if it is tied to purchases.
Most bonus offers, like Chase Freedom $200 Cash Back, are tied to a spending threshold. For example, you may earn 10,000 bonus points for spending $1,000 within 3 months. Thus, with most credit card bonus offers, you’ll avoid the tax man.
Surpassing The $600 Threshold
Another potential caveat in this issue is that rewards are growing. As card issuers compete for customers, larger bonus offers and more rewards are generally offered.
The IRS has a $600 reporting threshold. Any taxable income that is valued at $600 or more requires the issuer to send a 1099 form to the IRS and the customer. Of course, this should still be a non-issue for most cardholders, as most of their rewards are currently not taxable. However, keep in mind that, if the tax law is changed or you receive taxable rewards that are worth $600 or more, Uncle Sam will know.
An easy way to know whether or not the IRS has received direct communication on your rewards is to check your mail (or email). If you’ve received a 1099 tax form, so has the IRS. If you haven’t received this form, then the IRS probably hasn’t – unless yours was lost in the mail!
Always Consult a Tax Advisor if You Need Specific Advice
With the US Government up to it’s eyeballs in debt, it is likely that the IRS will play hardball with those who skip out on paying taxes. Sure, you earned the money, but the IRS doesn’t always play fair.
Keep in mind that the stated information is based on the most recent information that is available. It is meant to guide you on the issue of the potential taxation of your credit card rewards.
With the likelihood of the IRS digging deeper into your pockets and the potential hassles of not paying the required amount of taxes, it may be a good idea to consult a tax advisor if you have any questions or concerns regarding your specific financial situation.