RedSun

You still do not get it.

You can do an experiment and hire 10 different tax accountants to do your tax return. I figure you'll get 10 different answers. Some can be very different. Probably none of them will sort out your MS activities.

As several people here have said, folks all working to optimize their CC spending. If the spending is well within regular budgets, then no one can say organic spending is MS. But if someone runs $1MM to $5MM a year through their CCs, then it is a problem. Clearly OP stated those cases.

But if you want to pay tax on your maximizing your $1,500/quarter Chase Freedom spending, you sure welcome to do that. I'm not a tax accountant to advise you.

tuphat

I think that the greatest near-term risk from this decision is over-zealousness by credit card issuers with regard to information reporting, i.e., issuing 1099-MISCs for cash rewards paid to cardholders. Some card issuers may take a better-safe-then-sorry posture, knowing that failure to "properly" issue 1099s can bring penalties.

In such a case, holders would probably have little recourse against issuers, but would instead be faced with what at least some (me) would consider an erroneous 1099. Most advisors would suggest reporting the 1099 amount on the return, then subtracting the same amount with some sort of explanation. Simply ignoring the 1099 would increase the chance of an automated under reporting (AUR) notice for the return.

joker365

Here's a couple of basic thoughts:

1. Whether your gain is taxable or not rarely if ever depends on the amount of the gain.
2. If you made some money, it does not automatically mean you owe tax. For example, if you bought your primary residence for $300k and sold for $500k in a few years later -- you do not owe a tax on the 200k gained. Similarly, if you bought a gadget for $100 and later received $50 mail-in rebate, that $50 is not a taxable income to you. Heck, if you did something smart and received another $70 rebate on that same gadget purchase -- it is still not taxable, though you seemingly "got ahead". Same if you were purchasing a service rather than a gadget. Credit card rewards of all shapes and forms have been receiving this rebate treatment from IRS. The question whether credit card rewards are taxable has been asked of IRS many times and IRS has issued several rulings explicitly stating they are not taxable.

IRS is obviously unhappy with how the taxpayers took advantage of the rebate rule in this case. The court ruling however states that a gift card is a gadget as it has a product number (UPC?) and cannot be deposited to one's bank account making the associated credit card rewards nontaxable. The Judge also ruled that purchasing a money order or adding money to a reloadable card directly with a rewards credit card is not purchasing a gadget or a service, and therefore the resultant rewards are taxable.

It's unclear to me why the judge drew the line where he/she did. Both purchasing a money order or adding money to a reloadable card would appear to be purchasing a service. It's very clear with the money order: all entities selling money orders are designated by the government as Money Services Businesses, so buying a money order would be buying a service (?)

The other thing there seem to be a decent amount of confusion about is basis reduction. If the taxpayers sold a gift card on ebay, the basis in the gift card would have been reduced by the amount of credit card rewards and increased by the fee taxpayers paid when buying the gift card. To the extent ebay sale price was greater than the basis, taxpayers would have generated a taxable gain. However, no such thing is alleged to have happened. Quite the opposite, IRS says taxpayers consumed the gift cards themselves (by buying a money orders), which is probably why IRS did not pursue the argument the Judge appears to suggest could have been more promising.

Often1

Oh yes I do.

The sole question is whether a given transaction generates income. If it does, that income is taxable. Whether that treatment generates a tax liability and, if so, how much, depends.

But, whether an item is income does not depend on its size. For that, you are referring to the question of whether you are going to get caught.

Andy2

If I walk into Walmart with two $500 VGCs that have a reduced basis of $475 due to the rewards, and I swipe both of them and leave with a $999 money order, haven't I done a sale or exchange that generates a taxable capital gain?

That has always been the fundamental issue to me.

If the IRS just looks to tax the $50.59 of rewards that a person got from purchasing those two $500 VGSs on a 5% reward card, it isn't giving credit for the $5.95 fee on each card, or the money order fee, or the other costs to complete the transaction. In the case, the IRS used hindsight to try and tax a portion of the rewards based on activity of the taxpayer, while the judge seemed to prefer an analysis that would only tax certain activities (and only at the time of the activity).

But I have never been able to get over the potential sale/exchange. To me, that is potentially different than truly consuming the VGC, but granted a purist might say that buying a $1,000 television with those two VGCs would also be a sale or exchange, and if that were the case, the entire nontaxable Rebate Rule would be at risk.

joker365

Well there are two different scenarios. You enter walmart with two $500 gift cards and say "Hey, I'll give you these two if you give me $999 money order". Had that kind of scenario taken place the credit card rewards from buying two gift cards would have reduced your basis in said gift cards. But walmart will not engage in a transaction like that with you. You are not a vendor or supplier to walmart, you are a customer. They don't want your gift cards, they want to sell you goods and services, so they will ask you to swipe your cards on a POS terminal to spend your money with them. Now, swiping the cards would not be a taxable exchange where the basis in the cards would come into play. Your example with a $1000 TV is quite handy. I think we all agree you would not owe tax on the credit card rewards if you bought a $1000 TV and that's because the kind of transaction you make in doing so is not a taxable exchange. Even if it were somehow treated as one, money has basis equal to its face value, no matter how you got the money. This is mentioned in the ruling. So, when the money moves from your gift cards to walmart, the basis in this money is $1000, not $950.

Andy2

Very good analysis and explanation, Joker365.

If that is the result, it is going to be interesting if that holds up through the remainder of the process.

It would be nice if the court had better detailed that issue and officially held for the Petitioner on it, instead of everyone needing to back into it.

The court held that the direct purchases of money orders with the Amex Blue card generated taxable income on the rewards at the Magical Rite Aid because the money orders did not constitute a purchase of a good (which is consistent with your argument that there is no sale/exchange when VGCs are used to buy money orders). That holding was the reason it was reported as a win for the IRS, but we don't know how big the Rite Aid transactions were.

The IRS may have thought the judge would extend the same taxable treatment to the Amex Blue to VGSs to money orders transactions (without the IRS needing to argue for a modification to the Rebate Rule, or sale/exchange treatment, for those transactions), since it is likely that every F'ing one of the VGCs were used for either money order purchases or Credit Card Billpays at WalMart. But if the court declined to extend that same taxable treatment when VGCs were used as the intermediary step, that is a huge win for the taxpayers in the case. So maybe their attorney is justified in thumping his chest.

That would mean they earned a lot of nontaxable cash. Since it is a transaction that will never likely reoccur, hopefully there will be no changes in policy from the IRS because of it. There will never be another unlimited Amex Blue card, or another Dollar Coin opportunity.

RedSun

I think you still do not get it.

If I buy a $500 GC with a 5% CC. The GC has a 1% fee. But IRA can't say I make 4% income from this transaction alone. I get a $500 GC, not cold cash in my hand. So this 4% is not my income. Also, if I spend $500 and get a $550 Lowes GC, do I make $50 income? No. Those GCs are discounted, and do not have 100% cash value.

Say it another way, I use my 5% CC to buy $500 grocery. Yes, I get $25 discount (award) back to my CC. Does IRA require me to report $25 income again? No. This $25 is my CC award, not my income.

Per Oxford Dictionary: Income is money received, especially on a regular basis, for work or through investments.

So for the $1,500 Chase Freedom card case, it is only $1,500 each quarter, or $500 each month. The $25 CC award is never considered income. It is not regular work income or investment income that should be taxed.

Also, if I'm a busy consultant and travel 30 times a year for work. And I accumulated a lot of cashback or points. My travel cost is $100,000 per year on my CCs, but reimbursed by my office. Are those my MS income? No. This is all organic spending and I never do any MS here.

But if you do $2,000 or more GC everyday, then IRA can say that is your regular income. Because the total spending is $730,000 per year, much higher than what people take home as after-tax income. Clearly there is some regular working activities going on....

RedSun

It is not this so crystal clear.

Citi DC can be either cash or TY points. AmEx MR points can be redeemed as cash at Schwabs, or transferred to airlines. So are they cash or points or miles?

If Citi DC is used for organic spending, then the cash back is purchase discount, not profit, or income as someone said.... The CC award is the incentive provided by CC bank to entice (bribe) us to use its cards.

But if someone turns this into a job, then this CC rebates can be considered regular income like a MS side job.

garykung

First - if any interested party does not believe the Court is correct, they have the right to appeal.

Second - there is no indication that the Court was wrong. Congress has defined income broadly, including practically everything.

No, I did not. In fact - what you have said has exposed you have no idea what you are talking about.

1. Tax Court is a court of record that allows non-attorney to represent clients.

2. Tax Court filing fee is $60, while the DC filing fee is $402. (And yes - with DC, you have to pay the tax in question first.)

3. Although never used one before, my bet is using an admitted EA for Tax Court proceeding will definitely be cheaper using an attorney.

When you start quoting Oxford, you are the one who really don't know.

Specifically, the Congress has defined income as "Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) the following items:" (26 U.S.C. § 61).

The case has also explained the Congress' intent as practically everything unless exempted.

RedSun

Sure I do not know as you claimed.

But what I know is that, IRS would have a hell of time to prove that the 7,500 Chase UR points I received from Chase for each quarter will be considered my "income" and should be taxed. If so, almost all American households should be taxed. Then there would not be any court case to prove or disprove it.

There are several tests IRA has the burden of proof. IRS has to prove that manufactured spending really took place:

1. Out of the regular spending pattern: If your annual household income is $100,000, you can't prove that you spent $500,000 on CCs for regular spending. You can't claim that you have business activities on personal CCs. That will bring more trouble into business activities.
2. And, On a regular basis: If you have $10,000 spending on a single month, this does not prove that MS taking place. You could be spending to earn Hyatt free night offer. And use the VGCs to pay child's tuition or summer camp, or insurance bill.

The burden of proof for IRS is a big hurdle. Of course IRS can threaten taxpayers with some notices. But IRS still has to follow the laws.

So the bottom line is that, for most people, if you only do organic spending to maximize CC spending and rewards, there is nothing to worry. For whales who do seven figures and leave all paper trails on CC and bank account, they are the people have to worry about. For the people in the middle, this is some risk we need to be aware of.

garykung

You should think this way - given the established exception, why would IRS know about this case? Specifically, why would IRS know exactly how much the award has earned?

RedSun

Easy.

The CC banks suspected something from the huge spending. So this was reported. So IRS knows about it. That is all. And IRS is part of US Treasury. It has authority to subpoena all records from all banks. Banks are legally obligated to comply.

I do not think Chase will report anyone who optimizes the $1,500 quarterly spending. There are probably millions of people doing it.

garykung

Then you have nothing to worry. And watch out for AMEX.

Indeed - your issuer must have sold you out before IRS can act on it.

BTW - while IRS has the authority, it must also comply with all legal requirements. IRS can't simply subpoena records when IRS simply likes it.

RedSun

Banks are under multiple level of government regulations. They have to report suspicious activities to several levels of regulatory bodies. I used to work for a large bank years ago.

Banks have their own internal systems to monitor all banking and spending activities. When they do not like something, they can just suspend your accounts. If they suspect some wrongdoing, they can report to regulatory bodies. Or they can be fined. They would rather lose some customers and some businesses than incurring fines and bad publicity.

Then it is up to the Fed and IRS to decide if anyone has crossed the "red line". IRS will only go after the cases that they believe they have good chance of winning. They will go after those little guys who try to save $100 a month. Their attorney fees are much higher than that.