Tax News

Data Breach: Tax-Related Information for Taxpayers

A data breach is the intentional or unintentional release or theft of secure information. It can be the improper disposal of personally identifiable information in the trash or a sophisticated cyber-attack on corporate computers by criminals. It can affect companies large or small.  The one common link is the victim, the person whose identity, financial or personal information has been compromised.

data-breachWhat You Should Know About Data Breaches

Tax-related identity theft is when someone uses your Social Security number to file a false tax return claiming a fraudulent refund. Your tax account is most at risk if the data breach involves both your SSN and financial data, such as wages.

The Internal Revenue Service is committed to working with taxpayers to ensure that all tax accounts remain secure.  The IRS stops the vast majority of fraudulent tax returns.  If fraud is suspected, the IRS will contact you via mail with instructions.  However, some unfortunate taxpayers may discover they have been victimized by a data breach when they attempt to file electronically and have their returns rejected by the IRS as duplicates.

It’s important to note that not every data breach results in identity theft, and not every identity theft is tax-related identity theft.  Data breaches involving just credit card numbers, health records without SSNs or even driver’s  license numbers, while certainly serious, will not affect your federal or state tax return.

What to Do If You Are the Victim of a Data Breach

Determine what type of Personally Identifiable Information (PII) has been lost or stolen. It is important to know what kind of information has been stolen so you can take the appropriate steps. For example, a stolen credit card number will not affect your IRS tax account.  Regardless of the nature of the breach, you should stay in touch with the company that lost your data. Companies sometimes offer special services, such as credit monitoring services, to assist victims. In addition, you should take the following steps recommended by the Federal Trade Commission.

  • File a police report
  • File a complaint with the FTC
  • Notify at least one of the three major credit bureaus in writing — Equifax, Experian and TransUnion —  (preferably all three) to place a fraud alert on your credit file
  • Close any accounts opened without your permission

If you received IRS correspondence or your e-file tax return was rejected as a duplicate, take these additional steps with the IRS:

  • Submit an IRS Form 14039, Identity Theft Affidavit
  • File your tax return (most likely by paper) and attach Form 14039
  • Watch for any follow-up correspondence from the IRS and respond quickly.

Who Should File Form 14039?

Form 14039 — Identity Theft Affidavit should be used if your Social Security number has been compromised and IRS has informed you that you may be a victim of identity theft tax fraud or your e-file return was rejected as a duplicate. The fillable form is available at IRS.gov. Follow the instructions exactly. You can fax or mail it or submit it with your paper tax return if you have been prevented from filing because someone else has already filed a return using your SSN. You only need to file the form once. After the form is processed, you will receive a special number to use in place of your Social Security number to file your federal income tax returns.  This number can be used with electronic filing — but should only be used with your federal tax returns, not with your state tax returns.

70 Foreign Countries Agree To Share Tax Information With IRS

The Internal Revenue Service recently received a significant boost in its quest to collect the dues which it is rightfully owed. In an important bit of IRS Tax News, 77,000 foreign financial institutions in nearly 70 countries agreed to share tax information with the IRS. This historic announcement marks a milestone in the agency’s quest to combat international tax evasion.

As part of the agreement, banks and investment funds agreed to share information with the IRS about American citizens who own accounts at their institutions. The participating institutions include banks from Switzerland, the Bahamas and the Cayman Islands, each of which has a reputation for being tax havens. As of March 2015, these institutions began sharing names, account numbers and balances for U.S. account holders with the IRS.

Surprisingly, 515 Russian institutions are part of the agreement. This inclusion is despite the fact that these institutions were required to apply directly to the IRS to be part of the agreement because of halted communications stemming from the Ukraine conflict. The number of cooperating institutions is expected to rise in the coming weeks.

irs-logoWhat It Means for You

Honest taxpayers are unlikely to be directly impacted by this agreement. After all, tax evasion is illegal. Nonetheless, the agreement could have significant indirect consequences for all U.S. taxpayers. Specifically, this agreement should free up IRS employees investigating tax evasion internationally, providing more resources to seek out domestic instances of tax fraud. The knock-on effect result in more closely examined tax returns and more frequent audits. That said, honest taxpayers have little to fear, especially those with incomes under $200,000.

On the other hand, this news seems to signal the beginning of a commitment by the IRS to work more closely with foreign institutions regarding international tax issues. In an increasingly globalized world, more of today’s workforce completes assignments for international employers and clients. Anyone who has ever worked with or for a foreign company understands the hoops taxpayers must jump through come tax time. But with continued international cooperation, these hoops could diminish. That’s good news.

However the situation plays out, it bears monitoring. For now, all we know is that despite recent foreign political challenges, the U.S. government and its agencies – including the IRS – are willing to work with their international counterparts on lowering financial crimes. That’s even more good news.

IRS Hacked, 104,000 Taxpayers Impacted and Nearly $50 million Stolen: What Should You Do to Protect Yourself?

The IRS announced on Tuesday (5/26/2015) that identity thieves had attempted to access the accounts of 200,000 taxpayers through the IRS’s “Get Transcript” online application. The scary part is that the IRS has admitted that more than 104,000 of those attempts were successful. The hackers’ operation started in February and ran through mid-May. All in all, the IRS was tricked into sending nearly $50 million in refunds for fraudulent returns.

The IRS has started an investigation in the breach and has temporarily closed down the “Get Transcript” application, a service that allows taxpayers gain access to their information. Taxpayers who need access to old tax returns to apply for mortgage or college loans can now request them by snail mail.

irs_data_breachThe IRS is notifying the 200,000 taxpayers whose accounts were tampered with that their Social Security numbers and other personal financial information is in the hands of hackers. It is also offering complimentary credit monitoring to the 104,000 whose “Get Transcript” accounts were accessed to ensure their private information is not used by criminals to fill in bogus bank loans and credit card applications.

This is by no means the first time the IRS has been the victim of online crime. According to a report published by the U.S. Government Accountability Office in January 2015, identity thieves cheated the IRS out of $5.8 billion in falsely claimed refunds during 2013 alone.

Who Stole from the IRS?
According to Peter Roskam, Illinois republican and chairman of a House subcommittee that supervises the IRS, the IRS Commissioner John Koskinen said to him in a telephone call that the theft originated from within Russia. The IRS’s investigation is still ongoing and IRS officials have neither confirmed nor denied Roskam’s statement.

John Koskinen, the IRS commissioner, did say to the press that he was confident they weren’t dealing with amateurs. “These actually are organized crime syndicates that not only we but everybody in the financial industry are dealing with.”

How Did Identity Thieves Steal $50 Million from Taxpayers?
When you think of hackers stealing money from big corporations or government agencies you probably have the image of shady programmers strong-arming the security protocols of their victims’ servers with their sophisticated code; but this isn’t what happened here. Strictly speaking the IRS wasn’t hacked. The identity thieves didn’t need to hack their way into the IRS, because they had all the answers to the IRS’s identification confirmation questions.

As Peter Roskam put it, the identity thieves “went into the front door of the IRS and unlocked it with the key.” The hackers had already obtained personal information on taxpayers, such as their date of birth, address and Social Security information, from previous hacking heists. With that information thieves were able to clear the IRS’s multi-step authentication process, including several personal verification questions that usually only the taxpayer can answer.

What Should You Do?
First, don’t panic. Your personal information is already out there. A motivated hacker can easily obtain it for a few dollars. But this doesn’t mean you should sit on your hands. Consumers can, and should, make things harder for criminals. You could compare it to your home’s front door. No matter how much you spend on security, a professional burglar could break in, but that doesn’t mean you should leave the door open or that you shouldn’t invest in a decent security system.

Here are four things you can do right now to protect yourself after the IRS breach:

1.) Change your passwords again. This is an obvious but often overlooked measure after major breaches. Don’t use your name or words that can be found in a dictionary. The first thing hackers do is use programs that test every word in the dictionary. Instead, create your own secret codes by using anagrams or substituting letters from common words with numbers.

2.) Turn on multi-level authentication. Only use sites that offer you the option of confirming access by receiving a one-time code either via a phone message or email.

3.) Lie on security questions. With the advent of social networks and our propensity to over-share, most security questions are easy to hack. Finding out where someone went to high-school or their mother’s maiden name just isn’t that difficult anymore. Instead of offering truthful answers, provide a second password as your answer. This will make it much harder for hackers to guess your security answers.

4.) Monitor your credit. There are no fail proof security measures against identity theft. You can try to make it harder for criminals but the chances are you will fall victim to identity thieves sooner or later. You can minimize the damage of these attacks by regularly monitoring your credit by scanning your credit history with the three major credit reporting agencies.

Congress Extends “Temporary” Tax Cuts

As 2014 drew to a close, Congress voted to extend 54 “temporary” tax cuts for the 2014 tax year. The Senate vote finally passed the week after Congress was supposed to adjourn for the year, producing a collective sigh of relief among taxpayers. The numerous cuts will benefit a wide range of taxpayers, ranging from large businesses and corporations to struggling homeowners. The list below describes eight of the most popular deductions that were extended.

tax-cuts

  • Tuition deduction. Whether you itemize your taxes or not, this tax cut allows you to deduct up to $4,000 in tuition, fees and related expenses for post-secondary education for yourself or your dependents.
  • Mortgage insurance premiums. If you are required to pay mortgage insurance to your lender, this deduction allows you to deduct the cost of your premiums if you itemize your tax return.
  • Mortgage debt exclusion. The mortgage crisis has forced many homeowners into foreclosure or a short sale. If your house was sold for less than you owe, the bank will often forgive the debt. However, the IRS considers the amount forgiven to be taxable income. This deduction allows you to exclude the forgiven amount from your income.
  • Teachers’ deduction. Whether a teacher itemizes their tax return or not, this tax cut allows him or her to deduct up to $250 in out-of-pocket expenses for classroom supplies.
  • Commuting costs. Commuters can reduce their pre-tax income based on their commuting costs. People who drive to work and pay to park may deduct $250 per month. Commuters using mass transit may deduct $130 per month.
  • Sales tax. If you itemize your tax return, this measure allows you to deduct the state and local sales taxes you’ve paid in 2014 instead of state income taxes. This deduction especially benefits individuals living in one of seven states that do not have a state income tax.
  • Energy credit. You can deduct up to 10 percent of the cost of qualified energy-efficient products (between $50 and $500) purchased for your home in 2014. This deduction does not apply to new homes. The qualified product must have been bought and installed into your primary residence in 2014.
  • IRA withdrawals for charity. If you are over 70 1/2 years old, you may make a tax-free charitable contribution from your IRA up to $100,000. The contribution will not count as a deduction, but it will decrease your taxable income.

congressAs advantageous as these tax breaks may be in preparing your 2014 tax returns, don’t get used to them. They technically expired as of December 31, 2014, which means Congress will go through the same process at the end of this year. And while these cuts benefit millions of individuals, analysts estimate the extensions will add $42 billion to the national debt over the next 10 years.  Don’t be surprised if Congress allows many, if not all of these tax breaks to expire as a result.

Credit Administration Needs Better Oversight

The Treasury Inspector General for Tax Administration says that a quarter of all of Earned Income Tax Credit payments made in 2012 were not proper payments. Is this announcement from the Inspector General  IRS tax news or an indication of more deeply rooted problems? Either way, it appears the agency needs better oversight in administering EITC credits, which benefit so many low and moderate-income taxpayers and their families.

A Change In Payment Protocols Is Needed

Many EITC payments were made to people who were not entitled to them, while some legitimate recipients received the wrong amount. The total amount of improper EITC payments totaled an astonishing $14.5 billion of the $63 billion in credits paid, according to the report. It appears that the EITC represents one of the biggest risks for placing billions of dollars in the wrong hands.

The federal watchdog agency that monitors the Internal Revenue Service (IRS) operates under the Improper Payment Elimination Recovery Act of 2010. Its most recent report notes that agency oversight is seriously lacking. The amounts of those incorrect payments, unacceptably high at 25%, are significant and considerably above the government expectations for an error rate of 2.5%. Lax oversight is a major contributing factor to the total shortfall, estimated to total between $124 billion to $148 billion.

A Change In The System

A high level of mismanagement also occurs with the Additional Child Tax Credit, intended to assist larger low-income families in reducing their tax burden. Improper credits by the IRS totaled 25% to 30% of the program’s total payouts. These improperly administered credits amount to between $5.9 billion to $7.1 billion in total.

Auditors from the watchdog agency contend that the IRS needs to make significant changes in their existing systems. Clearly the present protocols have failed in preventing errors and improper payments

The watchdog agency recommended expanding IRS authority to allow the agency to make corrections in tax returns it receives to prevent improper payment of refundable tax credits. This change alone could avoid improper payments totaling more than $1.7 billion, according to the auditor.  While the IRS reported agreed with the watchdog agency’s recommendations, recent budget cuts continue to make it difficult — if not impossible — to effectively enforce compliance.

Jersey Shore Star Michael Sorrentino Charged with $9M Tax Fraud

Michael Sorrentino, better known as “The Situation,” made his fortune starring on the reality television show, “Jersey Shore.” And for all six seasons, he earned approximately $150,000 per episode. But now, Sorrentino has found himself in a situation he would rather have avoided.

“The Situation” Failed to Pay Taxes on $9M Income

Sorrentino and his older brother and business manager, Marc Sorrentino, were arrested and indicted early Septtember 24th, on a total of 7 different charges involving tax fraud. The pair was each charged with one count of conspiring to defraud the United States. In addition, Marc was charged with three counts of filing false tax returns for 2010-2012. Mike was charged with two of the same counts for that time period, along with being accused of failing to file a tax return in 2011, when he reportedly earned nearly $2 million. (Yahoo News)

The older brother and manager, Marc Sorrentino faces up to 14 years in prison for his charges, while Mike is facing up to 11 years along with up to $600,000.00 worth of fines. The pair plead not guilty in a Newark, NJ federal court yesterday, and are currently out on a $250,000 bond. Their next court appearance is scheduled for October 6, 2014.

These federal charges stem from the pair allegedly failing to pay taxes on nearly $9 million worth of income earned between 2010 and 2012. The indictment names the two individuals along with several companies reported to be owned by the pair. These companies include MPS Entertainment, Situation Nation, and Situation Productions.

Another Celebrity Caught by the IRS

The income, totaling $8.9 million dollars, reportedly was earned from a variety of sources besides the Jersey Shore. Personal and television appearances, ownership of an online clothing business, the publication of an autobiography and a comic book featuring the Situation as a superhero are just a few. Also, as he grew to be nearly as popular as co-star Snooki, his name was put on DVDs, clothing lines, jewelry, tuxedos, and designer sunglasses.

“The brothers allegedly claimed costly clothes and cars as business expenses and funneled company money into personal accounts,” claimed the U.S. Attorney. He went on to say “The law is absolutely clear: telling the truth to the IRS is not optional.” – Justice.gov

Sorrentino popularized the phrase, “Gym, Tan, Laundry” when he referred to the pre-party ritual of he and his housemates on Jersey Shore. His popularity on the show and his reputation for drinking heavily also lead him to many endorsement deals, including one with Devotion Vodka. He was also well known for showing off his finely toned abdominal muscles, leading him to release a work-out DVD and gain an endorsement with GNC Vitamins. He appeared on Season 11 of “Dancing With The Stars” but was eliminated after just the 4th round.

This makes him yet another well-paid celebrity, like Vanessa Williams and Conan O’Brien, has been targeted by the IRS.

When asked for a comment on his tax woes, Sorrentino reportedly said, “The situation will sort itself out.”

Corporate Tax Inversion: The Tax Strategy That’s Losing the IRS Big Bucks

During much of 2014, tax inversion stories were prominent in the news. Companies with household names like Pfizer, Walgreens and Burger King attempted, aborted or accomplished corporate maneuvers designed to create corporate tax inversions. Despite the firestorm of protest from lawmakers and the general public, all indications point to a continuation of corporations opting for the tax-saving strategy.

A corporate tax inversion is a method by which companies try to reduce their corporate tax bills by re-establishing headquarters overseas, typically through an acquisition. – Chicago Tribune

If you’re not familiar with the concept, the term “tax inversion” might send you running for an umbrella and a gas mask. In reality, what you might want to protect is your wallet. According to a May 2014 report issued by Deloitte, corporate tax inversion could result in a loss of nearly $20 billion in federal tax revenue from 2015 through 2024. Fewer corporate tax revenues may well translate to cuts in services or increases in taxes, fees and other expenses for individual taxpayers.

A More Agreeable (Tax) Climate

Have you noticed that many American companies are incorporated in Delaware, even though they have few or no actual operations there? That’s because Delaware has very liberal incorporation laws. Delaware is also considered one of the most tax-friendly states for corporations to set up their legal bases of operations. But for some companies, even Delaware is not tax-friendly enough.

Corporate tax inversion occurs when American companies purchase or merge with foreign companies and move their corporate headquarters to the foreign country where the other company is located.

This allows the American company to reduce its corporate tax burden on the operations located in its corporate headquarters, because the corporate income tax rate for many foreign countries is significantly lower than the 35 percent imposed by the United States. At the same time, the company retains access to its American customer base. Business as usual, but major tax savings.

Earnings Stripping and Hopscotching

Corporations must pay taxes on profits earned within the US. But corporate tax inversion may generate tax savings on domestic revenues as well. The process is called “earnings stripping,” and it works like this.

The newly established foreign headquarters grants a “loan” to its American division. The payments that the American division makes to the foreign headquarters are subtracted from its taxable profits.

According to an August 2014 report in Newsday, American corporations are hoarding more than $2 billion overseas. Hopscotching involves US based companies funneling profits earned overseas through a foreign headquarters. This tactic allows companies to invest those earnings without paying US corporate income tax.

Related article: Should We Abolish Corporate Income Taxes?

Have It Your Way, Eh?

Tech heavyweight Seagate and Stanley, a 170-year-old tool stalwart, are just two companies that relocated their headquarters outside the US in the opening years of the 21st century. A parade of American companies, including Tyco International, Fruit of the Loom and Ingersoll-Rand either considered or executed moving their headquarters outside the U.S. to cut corporate taxes during that period.

The legislative response was a 2004 law designed to put a halt to corporate defections. The 2004 law prohibited American companies from skirting US corporate income taxes by moving their headquarters overseas but leaving the same leadership and shareholders in place. Instead, American companies would be required to acquire or merge with a foreign company. Shareholders of the foreign company must acquire at least 20 percent of the shares for the new parent company. (International Tax Review)

The most recent wave of corporate defections was designed to follow the 2004 anti-inversion law. Pfizer launched a failed bid to purchase AstraZeneca and move its headquarters to London. Walgreens announced plans to acquire remaining 55 percent of Alliance Boots GmbH, a European drug store chain, but nixed plans to move its base of operations to Switzerland under intense criticism. (Des Moines Register)

The latest defector, Burger King, made an August 2014 announcement of its plans to acquire Canadian doughnut and coffee chain Tim Horton’s and move its corporate headquarters north of the border. The move allows Burger King to trim the corporate tax burden for its headquarters to 15 percent federal tax and 11.5 percent Ontario provincial tax. It is worth noting that Prime Minister Stephen Harper lowered Canada’s federal corporate tax rate from 28 percent to 15 percent after taking office in 2006.

What Congress (Won’t Likely) Do About Inversion

During the period between 2002 and 2004, anti-inversion legislation enjoyed strong bipartisan support in both houses of Congress. Such support is absent in the highly partisan environment of the 113th Congress. So, despite an anti-inversion bill introduced in May 2014 by Representative Sander Levin and Senator Carl Levin, it is unlikely that any substantive action will occur to address corporate tax inversions. That is, at least before the November 2014 election.

The Silver Lining: You Won’t Lose Your Job

Despite the fact that American corporations seem primed to continue announcing and carrying out corporate tax inversions, there is a silver lining. Unlike off shoring or outsourcing, tax inversions do not usually involve wholesale shipping of American jobs overseas.

So at least American workers won’t lose their jobs, even if American taxpayers eventually foot the bill to fill the hole created by corporate tax inversions.

Vanessa Williams Hit with $370,000 IRS Tax Lien

Singer, actress and former Miss America Vanessa Williams is the latest in a progression of celebrities to be hit by the IRS hammer. According to various news reports, the IRS filed a lien against Williams for $369,249 against the entertainer’s 2011 federal income tax return. Williams reportedly failed to pay an IRS assessment posted in 2012, which prompted the IRS to file the lien on August 13, 2014.

During the Hollywood segment of the Doug Banks Radio Show, the talk show hosts raise a good question: “How does this happen to celebrities?” After all, during the 2011 period of the lien, Williams had just finished Ugly Betty and was starring in Desperate Housewives. The money  was flowing, so why wasn’t the IRS paid?


Maybe it was the accountant’s error and Williams wasn’t even aware of the lien, similar to Conan O’Brien’s brush with the IRS earlier this year.

Here She Is . . .

This is not the first time the 51 year old Williams has had a brush with scandal. Soon after being crowned the first black Miss America in September 1983, nude photographs of the beauty queen that had been taken before her pageant days surfaced. The photos were published without her consent in Penthouse magazine. As a result of the scandal, Williams relinquished her crown to Suzette Charles.

Williams rebounded from the scandal, moving on to a successful recording career. Her debut album The Right Stuff, released in 1988, went gold, along with earning three Grammy nominations for Williams, including Best New Artist. Her third album, Save the Best for Last, released in 1994, went platinum. Williams has also enjoyed success on the silver screen and on television.

In Good Company

The notice for the lien was reportedly delivered to the office of Williams’s accountant in New York City, although Williams lives in Chappaqua, New York. There was no public statement from Williams or her accountant concerning whether Williams was aware of the lien or of her plans to handle the matter. (Comedian and talk show host Conan O’Brien nearly lost his house in Westerly, Rhode Island this year when notice of $8,000 in delinquent county taxes was delivered to the wrong address.)

Other celebrities who have run into trouble with the IRS over unpaid federal income taxes include Lauryn Hill, former lead singer for the Fugees, Courtney Love, widow of grunge rocker Kurt Cobain and singer for the group Hole; soul singer Lionel Richie, rapper Flo Rida and action star Wesley Snipes. Both Hill and Snipes served time in federal prison for failure to pay federal income taxes. At present, there is no indication that criminal charges are pending against Williams.

Conan O’Brien Pays Back Taxes, Avoids Home Auction

In the 2003 film House of Sand and Fog, Jennifer Connolly’s character loses her house due to nonpayment of a relatively small amount of delinquent county property taxes. Ben Kingsley’s character purchases the house at auction for a fraction of its appraised value and begins making renovations to the property. The movie ends with tragic loss of life – and Connolly’s character never gets her house back.

Comedian Conan O’Brien didn’t face tragedy on this scale, but he did come within days of losing his house, valued at more than $720, 000, due to $8,000 in delinquent taxes. The home was one of several that were slated for auction on Tuesday, June 24 by the town of Westerly, Rhode Island, where the house is located. (Source: USAToday)

Lost in the Mail

O’Brien, whose late night talk show on TBS has been renewed through 2018, was not facing financial difficulties that prevented him from paying the tax bill. Instead, the bill was apparently mailed to the wrong address and never reached his accountant in Los Angeles. O’Brien only learned of the risk of losing his house through a reporter’s story published in the Westerly Sun. O’Brien paid the bill on June 20 – as soon as he learned about the mix-up.

The heads-up from the local newspaper came just in time. As soon as O’Brien posted payment on the house, it was pulled from the auction list. Other homeowners who have gotten into arrears with their property taxes have not been nearly so fortunate.

Other celebrities in the news for tax troubles: Lauryn Hill, Courtney Love, Teresa Guidice

Search and Seizure

The story depicted in House of Sand and Fog was highly dramatized in the interest of drawing an audience. But the circumstances surrounding Connolly’s character losing her home and Kingsley’s character being able to purchase it for cheap were fairly accurate. Like the Treasury Department and the IRS, local municipalities and counties are serious about collecting tax revenues. Even when the collection process involves conducting fire sales of property owned by delinquent taxpayers.

Local and county governments routinely seize and sell properties due to unpaid property taxes that total only a fraction of the value of the homes that have been seized. While the execution of the policy can appear borderline ridiculous at times, the principle behind the practice is understandable. After all, a significant portion of the revenue of a city, town or county is derived from property taxes. No property tax collections=no revenue.

Want to know how ridiculous? Earlier this year, Pennsylvania widow Eileen Battisti lost her $280,000 home over a measly $6.30 tax bill. That’s right, six bucks.

Due Diligence

O’Brien’s near-loss of his home also illustrates the need for taxpayers to take a proactive approach to managing their affairs. In O’Brien’s case, the mistake was not made by him or by his accountant. Nonetheless, to learn about your own tax troubles in the news is risky. Had he not paid the amount in arrears in time, he would have lost the house because of a bit of lost mail.

It is possible that O’Brien could have taken legal action had the auction gone ahead. But the process would have been complex and messy, especially if his house had been purchased by a good faith purchaser in the interim. You can bet that O’Brien and his accountant will examine his financial affairs with a fine tooth comb going forward to prevent a similar incident in the future.

Taxed! Frequent Flyer Miles

In 2012, a Citibank customer received a 1099 tax form informing him he was liable to pay $625 in taxes for the 25,000 American Airlines miles he had received as a “gift” for opening a checking and savings account package. Needless to say, he was shocked to find out that as far the the IRS was concerned his frequent flyer miles were taxable income. He and others in his situation complained.

However, Citibank was not to blame; the bank was simply following IRS taxation rules. This story was enough to send droves of clients running for cover from credit card rewards programs altogether out of fear of being hit with unexpected tax bills. Even respectable finance advice outlets overreacted to these stories and provided inaccurate and unhelpful advice on how the IRS taxes credit card reward points. This is sad. Customers who ignore credit card reward points are missing out on a great way of getting free cash just by being smart about how they pay for their everyday living expenses.

If, like me, you carefully collect credit card points throughout the year to finance the lion’s share of your vacation expenses, you may have wondered – or even worried — whether you should declare your hard-earned points when it comes to filing your tax return. Although the IRS could be clearer on how it treats credit card rewards, it has published information on the matter. So finding out your tax liability is just a matter of digging into the murky waters of IRS tax regulations publications. I know, you’ve got better things to do; but I don’t. So I did all the heavy reading for you. You’re welcome.

Nontaxable Discounts and Rebates Vs. Taxable Interest and Bribes

IRS Publication 17 provides a detailed breakdown of which sources of income are taxable and which are not. I’m afraid there are no surprises here. Pretty much every type of income you can think of is taxable. This includes unemployment benefits, life insurance proceeds, alimony, gambling earnings, lotteries, raffles and even bribes. Yes, the IRS publication actually says: “If you receive a bribe, include it in your income.”

Nevertheless, there are two sources of income the IRS does not tax: rebates and rewards. Not surprisingly, there is a caveat when it comes to rewards: “If you receive a reward for providing information, include it in your income.” So does that include credit card rewards or not? This lack of clarity is what has created the current confusion, which is why the IRS published a specific statement on frequent flyer miles and credit card points in their 2002-18 Announcement.

The statement provided the following clarification:

“The IRS will not assert that any taxpayer has understated his federal tax liability by reason of the receipt of personal use of frequent flyer miles or other in-kind promotional benefits.” – IRS.gov

In classic IRS style the paragraph finishes with the tip “Any future guidance on the taxability of these benefits will be applied prospectively.” This means that, as of 2013, the IRS does not require you to declare the cash value of their credit card rewards and frequent flyer miles when you file your taxes; and even if they were to tax them in the future it will not be charged retroactively.

However, there is a big exception to this general rule when it comes to rewards you receive for making deposits or opening an account with a bank or other financial institution. In these cases the IRS considers the rewards as interest and therefore taxable. The IRS Publication 550 Investment Income and Expenses specifically says “for deposits of less than $5,000, gifts or services valued at more than $10 must be reported as interest. For deposits of $5,000 or more, gifts or services valued at more than $20 must be reported as interest.” This exception is what triggered the $625 tax bill for the Citibank customer mentioned at the outset.

The Bottom Line

In short, the IRS treats credit card rewards you earn when you purchase things, such as cash back, frequent flyer miles and points, as a reduction in the purchase price or as a rebate, which are not taxable. So you don’t have to worry about declaring your precious rewards as long as you don’t earn them by making a deposit (not a purchase) when opening an account.

One Last Caveat for Business Owners

The reason credit card rewards are not taxable income is because the IRS considers them a discount or price reduction, not as interest or as prize. Unfortunately, this also means you cannot claim as a business expense any item you buy or saving you receive with your credit card reward points. For instance, if a $2,000 business flight only costs you $1,000 after using your frequent flyer miles, you may only claim $1,000 toward travel expenses–not the full ticket value.

This article was written by staff writer Andrew Latham. His mission is to help fight your evil debt blob and get your personal finances in tip top shape.
Copyright © 2013 Andrew Latham
Photo: The-Lane-Team