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You're savoring a tropical vacation and congratulating yourself for using credit card reward points to pay for it. Suddenly, an unwelcome thought strikes: "Do I have to pay taxes on these credit card rewards?" Relax and enjoy your mai tai: Credit card rewards are generally not taxable. There are a few exceptions you should know about, however. Keep reading to find out how the IRS treats credit card rewards and how to know when you need to report your rewards on your taxes.
Are Your Credit Card Rewards Taxable?
Konstantin and Nadezhda Anikeev made headlines earlier this year after the IRS contended they owed taxes on more than $300,000 in Rewards Dollars they earned using American Express cards in 2013 and 2014. When the Anikeevs took the case to court, a judge ruled that most of the rewards were rebates and thus not taxable. However, he determined Rewards Dollars earned from purchasing cash equivalents—buying money orders and reloading reloadable debit cards—were taxable.
If you read the fine print of your credit card agreement, chances are you'll notice that cash-equivalent purchases such as money orders and cash advances are excluded from earning rewards. But what about the miles, points or cash back you earn from everyday purchases on rewards credit cards? While the IRS taxes income, these rewards aren't considered to be income. Instead, they're considered to be rebates, discounts or bonuses. While income is taxable, rebates and discounts are not. What about bonuses? Well, that depends.
If a credit card requires you to spend a certain amount of money to earn a bonus, then those bonus rewards aren't taxable. For example, if you receive $150 cash back for spending $1,000 in the first three months after account opening, you don't have to declare that $150 as income on your taxes.
It's a different situation if you didn't need to do anything to get the rewards. If you automatically get a $150 gift card after being approved for a credit card, with no spending requirement, that $150 bonus is considered income and is taxable.
When you earn a bonus with no spending requirement, the credit card company may even send you a Form 1099-INT or Form 1099-MISC specifying the amount of income you earned. You'll need to report the bonus income on your taxes and submit the tax form to the IRS. Even if you don't receive a tax form from the credit card company, you still need to report this type of bonus as income when you file your tax return, so keep track of any such bonuses you earn.
Are Business Credit Card Rewards Taxable?
Rewards earned with a business credit card are treated the same as consumer credit card rewards when it comes to income taxes. However, it's important to be aware that business credit card rewards can affect the amount you deduct on your taxes. That's because you can only deduct the net cost of business expenses, and credit card rewards may lower that cost.
Suppose you bought $1,000 worth of computer equipment with your business credit card and earned $20 in cash back rewards for doing so. Normally, you'd be able to deduct the full $1,000 as a business expense. In this case, however, the $20 reward reduces your net cost by $20, so you can only deduct $980. (By the same token, using a $20 discount coupon on the purchase or getting a $20 rebate from the manufacturer would also reduce your net cost and affect the amount you could deduct on your taxes.)
Enjoy Rewards Tax-Free
Rewards credit cards have a lot to offer. They can help you earn points or miles to pay for a trip, give you cash back on purchases, and provide travel and purchase protection and other benefits. Knowing that these perks are almost always tax-free is just the icing on the cake.
Are you thinking of getting a new rewards card? To qualify for most rewards credit cards, you'll need good to excellent credit. If you're not quite sure where your credit score stands, get a free copy of your report from all three credit bureaus through AnnualCreditReport.com. You can also check your credit report and credit score for free through Experian.
If your credit score is less than stellar, it's worth taking some time to improve it before you apply for a rewards card. Consider using Experian CreditMatch™ to get paired with rewards credit cards suitable for your credit profile, which can take a lot of the guesswork out of finding your next credit card.