Rewards cards such as
) Venture Card have their advantages. Sign up and you'll enjoy
up-front bonuses and generous mileage payouts to spend on free
travel. There's just one problem: "free" might not be free much
columnist David Lazarus reported that
) is sending tax statements to customers who received miles for
signing up for a checking or savings account. Each mile is worth
$0.025 in taxable income, Citi says. But they're wrong.
Why miles shouldn't be taxable
Before I get into why, let's talk about what's actually
happening. Citi is sending statements to the Internal Revenue
Service that show income, just as all banks send the IRS 1099
statements reporting interest income during the year. Brokerages
send in similar forms reporting dividend income.
A copy of every year-end tax statement you have is sent to the
feds. Fail to report the numbers within, and your chances of
audit rise. Thus, in kicking off statements, Citi has put
customers who were expecting free miles to be, well,
in a compromising position. Report the (ahem) "income" or risk an
unwanted visit from Uncle Sam.
For its part, Citi told Lazarus that any prize or award that
exceeds $600 must be reported to the IRS as taxable income per
the 2012 instructions for IRS F orm 1099-MISC. The feds wouldn't
clarify for him whether Citi was right or wrong in its
The math of mileage
I've never been and won't ever be a tax agent, so I can't speak
to the issue of taxability, but I do know that Citi's math is
Washingtonian in its fuzziness. No airline program gets within
spitting distance of offering $0.025 a mile worth of value to its
Travel hacking site Nerd Wallet did the math and found
that Continental's OnePass offered the most at $0.0101 a mile of
value. But that was before the merger that created
) . We're only now seeing the effects of a combined program, but
it's possible that the carrier's new Mileage Plus will offer not
much more than the $0.0083 a mile in value it has
Or consider the Venture Card. Capital One's terms and
conditions say the company will reimburse $100 of airfare for
every 10,000 miles spent, or $0.01 a mile.
) allows its Membership Rewards customers to exchange 15,000
points for a $150 gift card, also $0.01 per point.
Most consider roughly $0.01 a mile the industry standard when
valuing frequent flier miles. In Citi's case, opening an account
qualified some for up to 23,500 American AAdvantage miles.
Nerd Wallet estimates the per-mile value of bankrupt
American's program at $0.0076. But even if you call it the
industry standard of $0.01, Citi isn't just sticking customers
with a tax bill they didn't expect -- the bank is also grossly
overstating mileage income, and therefore the resulting tax
The other math of mileage
Even so, it's hard to blame Citi for overstating the value of
miles. Banks make so much from offering them. Again, consider the
Venture Card. Capital One dishes out two miles for every $1
spent. With interchange fee income, interest charges, and other
fees that result from that extra spending, paying what amounts to
$0.02 per dollar is a bargain. This, Fool, is a big part of why
Capital One's U.S. credit card business enjoyed 46.5% pre-tax
margins last year.
Citi doesn't do quite as well with a 31.5% pre-tax margin in
its consumer banking segment, while American Express trails the
pack at 28.7%. Yet I think it's fair to say maintaining those
levels would be much harder without virtually free inducements
such as miles to draw in potential customers.
United Continental and its peers enjoy a similar benefit.
Mileage is a huge profit driver for how it draws in loyal flyers
who tend to pay higher overall fares for business travel. Some
even buy miles directly at what amount to outrageous rates. As of
this writing, 2,000 miles that buy roughly $20 worth of
redemption value will cost you $75.25. For carriers like banks,
miles are a margin-maker.
What If the IRS acts?
Lazarus didn't get much when he asked the IRS to rule on Citi's
decision, which leads me to believe that other issuers won't
follow its lead. But if they do -- or if the feds decide that
miles are income -- then it'll gut the value of rewards credit
cards. Or at the very least, it might entice some travel hackers
to gather up less than the $600 value limit across varying
programs and then combine miles via trading portals such as
Points.com. You can bet banks are hoping it doesn't come to that;
sustained use increases the odds of collecting interest and
In the meantime, I'd strongly advise against signing up for
any Citi-sponsored program that offers miles as an enticement.
Also, be sure to read the terms and conditions before accepting
any rewards card offer. What seems like a no-brainer could trap
you with fees or payments you hadn't banked on.
And let's face it, if given the choice, we'd all rather earn
than pay. This is as true for stocks as it is bank deals. I know
because the Fool's free report profiling
11 high-yield dividend stocks
remains one of our most popular.
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