Not deductible since there is no basis. If you pay an employee for the miles, and include the payment in the employee's income, then that payment is deductible.

Your comment regarding the charitable contribution is interesting and I have long argued the same thing. If the frequent flier miles constitute a capital asset and are held for more than a year, you get the greater of FMV (probably 1 - 1.5 cents per mile) or basis ($0) as the deduction. Obviously the FMV is larger. The IRS can be expected to argue strenuously that frequent flier miles do not constitute a capital asset, thereby limiting you to a deduction for basis ($0). The IRS has I believe in fact issued guidance stating that you don't get a charitable contribution deduction for miles unless basis exists and I have seen airlines repeat this rule in their literature.

Since there are so many other transactions with respect to which we argue that the miles are worthless, the IRS also might prevail arguing that the FMV of the miles are $0. They might in fact give you the charitable contribution but try to tax you on other transactions. The IRS guidance holding that miles are nontaxable is a lot more restrictive than the popular press states.

Too small of an issue to litigate over, unless someone does it for fun. I've always thought that miles constitute a capital asset, although I see the contrary arguments. Anyone else who deals with the tax law care to offer input?