Tax Court rules some MS now taxable
 

In 2013-2014, a couple did over $6 million in spend and made about $300,000 profit at 5%. IRS says pay up.

DOC: Tax Court: Cash Reward Profits from Credit Card Manufactured Spend could be Taxable - Doctor Of Credit

Miles to Memories: Credit Card Rewards Are Partly Taxable Per New Court Case (milestomemories.com)

I don't think anyone doing a few hundred thousand in spend has much to worry about. But I thought I'd start a post about it because it's in the news, and I don't want it to take over other threads (already saw it start to be discussed in at least one thread)

The real unanswered question for us from the IRS is..........
"How much is too much".

If I were a whale who had been doing 7 digits of spend a year for the past 6-8 years, I would be concerned.

This is the exact case I think many of us had feared would occur, especially with the numerous posts from people visited by the IRS Criminal Investigation Division. Fortunately, nothing came from those visits, and contrary to predictions by numerous posters, particularly Often1, we never saw significant Structuring investigations from Manufactured Spending. But at $4 million a year in money order deposits into the bank, some types of reporting must have occurred, and eventually a civil audit occurred.

And fortunately, the court reaffirmed the rebate rule. For the few thousand out of millions that they spent on food and clothing, the cash rebate just reduced the basis of what was purchased, and wasn’t taxable. The problem with Manufactured Spending for variable load cards that you convert to cash with a cash back card is that at the end of the day all you have left is cash. And it is difficult to argue that a cash profit isn’t taxable. So the masses will totally misunderstand this court case.

If all you have left at the end of the transaction are miles from this same type of purchasing variable load cards that are converted to cash,, you can make an argument that the miles you obtained are not worth very much, although that argument might not prevail. We still have that issue throughout Flyertalk, with a very wide range of value that various issuers of AA miles use when essentially issuing those miles as interest on bank accounts.

And if the “currency” you have left after a variable load card to cash MS transaction is something that just allows you buy travel at a deep discount within a closed travel booking system, there is some argument (although weak if the discount is too large) that the currency is merely a valueless coupon, and the “profit” from the transaction should be a reduction to the basis of the purchased travel instead of being taxable income.

But the pure cash profit from the Blue Card transactions when used for buying variable load cards that were converted to cash was the perfect storm. Fortunately the Statute of Limitations has closed for the most profitable years for most FTers since the limitations and closures have changed the landscape.

Other than the Statute of Limitations issue, I don’t see why the volume of transactions matters. If $300,000 of profit is taxable, $3,000 of profit would be taxable just the same.

I think that even the IRS will not waste the time to go after the 4 digit or even the 5 digit MSer.

However, when you start talking 6 and 7 digits of MSing, then you are starting to talk significant money, especially if you add on fees and penalties.

Again, I reiterate, whales should be concerned about getting an IRS letter.

Worth noting that the case is a Rule 155 case, which is why you don't see how much is ultimately owed. The court gave some guidelines and now the parties go back and do the calculations based on those guidelines. We may never know the final result unless the parties go back to court. Some of the guidelines were favorable to the taxpayers, and the law firm and Dan's Deals point that out. And of course the problem with any court case is that the court just addresses what the parties argue, and may not give a different answer if neither party gets it correct (if there is a correct answer). I always thought that if a person buys $1,000 worth of variable load cards, pays $11.90 in fees, gets a $50.60 credit on his reward credit card, he has a basis of $961.30 in those cards. If he uses those $1,000 of variable load cards to buy a $999 money order, he has a short-term taxable capital gain of $37.70 (he bought $999 for $961.30). But if he is just a regular person who did this transaction and used the $1,000 of variable cards to buy food, gas, clothing, he doesn't have any taxable income since he just gets a basis of $961.30 in the "regular" stuff he bought.

The IRS didn't argue for that gain in the court case, but seemed to simply have argued that the statement credit was taxable, presumably as a result of what the taxpayers did before and after getting the statement credit. Of course some would argue that since $1 is always worth $1, perhaps there was never any gain on the purchase of the money order (or the eventual use of the money order if the benefit somehow transferred from the variable load card to the money order). So maybe there was a reason the IRS didn't argue that a taxable capital gain exists.

Anyway, we may never really know how it turns out, but it is worth reading the thoughts of those who say the declaration of the case being a big win for the IRS to have been misleading.

https://www.dansdeals.com/points-tra...axable-income/

https://activerain.com/blogsview/563...tes-tax-court-

It seems clear to me that MS for cash profit is taxable, because cash profits are always taxable.

MS for airline miles, hotel status, etc. is not taxable, because those items are not taxable.

I think that is the conclusion that a lot of us would come to.

Not because miles can’t be taxable (Citi famously issued 1099s a few years ago for miles earned from opening bank accounts in certain circumstances), but because many of us would argue that miles/points don’t have much value.

In that same $1,000 or so Manufactured Spending transaction generating the $37 or so of profit with a 5 percent cash back card, if someone now used the Citi Mile-up card and got 2,024 AA miles after incurring $12.90 of fees, many of us would argue that those 2,024 AA miles aren’t worth any more than the $12.90 of fees. It is just a way of purchasing travel at a discount compared to the normal retail cash price. If you spend enough in $12.90 fees per 2,024 AA miles and you want to go to Europe in Business Class, maybe you finally get to 115,000 AA miles and hope there is award availability. The miles are likely worth what you pay for them in fees in a Manufactured Spending transaction. To me, they basically function as a coupon that you may or may not ever redeem. But it is a coupon you have to purchase with the knowledge that it may or may not ever really be relatively valuable. And you can’t resell that coupon once you buy it - it has no cash value.

I think that Andy2 has the probable reasoning behind the IRS's decision to go after this couple.

Trying to determine the value of airline and hotel points is a fool's errand. While one might wish to say that a particular point is worth, say, $0.01, this is actually a guess dependant upon so many variables that not even frequent flyers agree when trying to establish it.

OTOH, a 2-5% cashback card gives you a definite value for the spend you do. While there is no doubt that this is a rebate when purchasing a product, it can easily be said that it is income when purchasing a monetary equivalent such as a VGC and converting the same into another monetary equivalent known as a money order.

The majority of us can rest easy because, like many who get cash income (from selling on ebay or pocketing tips obtained on many jobs not requiring reporting of same) the amount received is way too small to interest the IRS's collection department.

However, as witnessed from the above tax court case, the general truism still holds....

"Pigs get fed, but hogs get slaughtered" :o :D

This taxpayer should have gone to a refund forum (District Court or Court of Federal Claims), not to the Tax Court. The aforementioned courts would (IMHO) have been more likely to hold the IRS to its published "rebate rule" position, rather than making up new law, viz., a "cash equivalent exception." Taxpayer would have had to front the cash, but chances of prevailing would have increased significantly. I think they got bad legal advice.

And to your point about smaller volumes being safer, this type of adjustment requires a lot of hands-on auditing, so it isn't like the IRS is going to be able to mail out assessments.

It does raise an interesting comedy question.

Presumably, it was reports issued by the banks (we don't know if it was CTRs, SARs, etc) that got these seemingly ordinary wage earners audited.

But the first step of most civil audits is the auditor making the presumption that all bank deposits are taxable income, and making the taxpayers prove otherwise if the deposits exceed the reported income.

Kind of awkward if the auditor sees deposits of $5 million or so from pretty ordinary wage earners. Someone on one of the websites referenced above requested the more detailed court filings. I do wonder what kind of proof the auditor requested to prove that none of the deposits were income (other than the purported profit portion).

That is why I am a fan of just mailing the money orders to pay the credit cards, but that generates its own issue for the one in a thousand that gets lost and you have to file a refund claim. And of course the stamp adds to the costs, and the credit card company sees the entirety of what you are doing.

The other comedy of all of this is just how damn much this added up to for Amex. Think about all the FTers and FWers who did this, and the fact that there were whales doing it into the millions.

None of us are sure how much, if anything, AMEX got from credit card charges on this. I have always doubted that supermarkets or drugstores were paying much of anything to the credit card companies for these type of sales. It wouldn't make sense for them to do so. So AMEX was paying a lot of 5% rewards, and allowing massive churning of credit lines on the card. It was great fun while it lasted, but I wonder if it generates some very unpleasant memories for some folks at AMEX.

". In 2013 and 2014 petitioners deposited a combined $4,028,743 in money orders into their bank accounts." RESPECT!

Figuring a very conservative 88 cents per $1000 of MO's, that's $3500 of MO fees for WM, et. al.

The case got overturned and they ruled that that receiving points on the credit card is not a taxable event.

From the lawyer in the case

I am not so sure about this. At the minimum, if IRS can assess the value of what has been obtained, it can trigger a taxable event.

FWIW - many programs do sell points on the side, which provides IRS some referencing data,

Tax Court is a better court.

To begin with, costs with Tax Court is cheaper than the others. Also, even District Court or Court of Federal Claims refers the Tax Court precedent. Beside - there is no indication that other courts would rule differently. Specifically, IRC defines income broadly with limited exceptions. So it is quite a burden to overcome.

It did not.

First - the decision was filed 3 days ago. It is literally impossible that the 2nd/Federal Circuit can overturn the case that fast.

Second - the original decision was "Therefore, we uphold respondent's inclusion in income of the related Reward Dollars for the direct purchases of money orders and the cash infusions to the reloadable debit cards," which the IRS was the respondent, i.e. IRS won.

It just got decided a couple of days ago, so it definitely didn't get overturned.

It is a Tax Court Memorandum case, which doesn't have much precedence, and it is a Rule 155 case, so now the parties are supposed to go back and do the detailed tax calculations based on the court's decision.

At first, Bloomberg (a tax service) took some of the statements by the judge were very anti-taxpayer and summarized the case as a taxpayer defeat.

The lawyer for the taxpayer is now thumping his chest and pointing out all of pro-taxpayer things the judge said.

It is going to be a difficult case for the IRS and the taxpayer to resolve under final computation phase of the case because some of the things the court said were rather contradictory.

In fairness to the court, it expressed frustration that the IRS did not complete its analysis. The IRS initially argued in the briefs that the rebate from the AMEX statement credits should be applied to the variable load cards, and that rebate should cause the purchase of money orders with the variable load cards to be taxable. But for some reason, the IRS abandoned that argument during the case, and it seems (to me, anyway, based on the language in the case) that the court seems to think that is the correct result. But as a result of the IRS not arguing for that result in its final arguments, the court might not be able to impose that result. So the lawyer for the taxpayer is declaring a big victory. That is complicated by the fact that the taxpayers appeared to have found a Rite Aid that allowed the direct purchases of money orders with the Amex Blue Cards. Consequently, when the court said that purchases of money orders with the Amex generated taxable income as a result of the 5% cashback, the lawyer for the taxpayer seems to be interpreting that judgement as just applying to those Rite Aid transactions, not the ones we are more familiar with - the purchase of money orders with the gift cards that were purchased with the Amex card. This is supported by the judge's declaration that the purchase of the gift cards with the Amex did not generate a taxable transaction, but it goes against the "flavor" of how the court phrased its overall ruling (at least in my opinion).

It seems pretty obvious that these folks might not have a pleasant time when they get together for the tax calculation meeting.

And it wouldn't appear that the IRS would be prohibited from arguing for other taxpayers that the purchase of money orders with "reduced basis" gift cards generates taxable income, especially since the judge seemed to advocate for that conclusion. But some commentators about the case seem to think the IRS will have difficulty imposing that result on these particular taxpayers in this particular case, since they abandoned that argument at a critical part of the proceeding. Of course maybe the IRS doesn't think that is the correct result. Who knows? I suppose it is possible the IRS might argue in the tax calculation meeting that the court meant in its decision that all of the purchases of money orders with credit/debit cards that were associated with the 5% cashback resulted in taxable income, not just the Rite Aid ones (even though certain sentences in the case are not consistent with that interpretation).

Reversed, not?

Don't fall for law firm marketing hype. Read the Opinion and then let us know if you really believe that the IRS determination was reversed significantly to the taxpayer's advantage.