srallen

Why is it that you pay income tax on airline miles won (such as in the Tom Thumb thing: http://www.flyertalk.com/forum/showthread.php?t=597558) but you don't pay taxes on airline miles given to you by the airline for opening a credit card account?

boston aa flyer

B/c winnings are viewed as income and you haven't given them something in exchange, like your business; like when you get a credit card.

FWAAA

Exactly. Miles won in a contest are no different from any other contest prize; income is income, even if it's airline miles. Section 61 of the Code clearly supports this proposition.

Miles earned from flying or restaurant meals or car rental or hotel stays or credit card usage are a rebate of a portion of the price paid for the underlying service - and thus are generally not taxable to the recipient as long as the underlying service is a personal expense (and not deducted as a business expense). For example, I buy a car for personal use for $35k and get a $5k rebate - the $5k is generally not taxable income.

There is a very good tax policy argument to support the taxation of miles earned by employees on their employer-paid travel - but thus far, the IRS hasn't pushed that one.

There's also a very good tax policy argument to support a reduction of the Section 162 business expense deduction for the value of the miles earned on deductible business travel, especially for self-employed business people or non-reimbursed business travel of employees. Example: Pay $500 for ticket, get $50 worth of miles. The pure tax deduction for the travel should be $450, since the airline kicked back $50 worth of miles. But fortunately for us, the IRS hasn't pushed this one either.

sllevin

Another part of the reason the IRS has stayed away from taxing miles earned is because it would open a crazy-storm of what miles are worth, and what you paid for them.

For example, flying SFO-JFK yields, say, 2500 miles. But the cost of those miles to you can vary dramatically, if you are on a $250 ticket or a last minute $1600 Y fare.

Also, people would then, in large scale, contest what the actual value of miles were. For example, there's a good case saying that miles have a highly impaired value well under one cent -- for the case of comparing 25,000 miles to a domestic ticket purchasable for well under $200, combined with the significant lack of availability compared to those fares -- to the argument that they are worth 10 cents a mile because you can use 125,000 miles in place of a $12,500 ticket.

This is a can of worms even the IRS would prefer to keep closed because the value of what they could get in taxes would be more than outweighed by the cost of what it would take to collect on it.

Especially once someone points out that the airlines themselves put miles on their books as a very tiny liability (I think around $.0015 (.15 of a penny) for their financials.

Steve

ananthar

Delta lists its liability as below $0.001 : around $21-$24 per 25,000 miles, this being the sum of the incremental cost of providing a domestic award flight ($6-$9, for the cost of extra fuel and a soda) plus $15 average loss for accidentally giving away a seat they could have sold (based on a 5% chance their capacity control software messed up and they lost out on a $300 ticket in the cheapest sale bucket).

This is important for those winning miles prices, since the organization awarding the prize often reports the value of the miles as $0.024 to the IRSe, based on what the airline charges for miles, but the IRS allows you to contest that based on a fair market value analysis, and the above analysis allows you to claim miles are worth only around $0.001.

mahasamatman

While miles earned by employees are not taxable, the IRS has ruled that if the miles go to the employer, they are taxable. That's why most (if not all by now) employers let the employees keep the miles.

mahasamatman

I seriously doubt you could get away claiming Delta's incremental cost as "fair market value". About the best you can do is to compare the miles to the consumer cost of a flight - if you can convince them that you would use 25,000 miles for a $250 flight, they would value the miles at $0.01.

Analise

Airlines like to make it very clear that airline miles are owned exclusively by the airlines. If we own something, we can sell it for instance. So how can airline customers be taxed on something they don't own?

dhuey

An excellent explanation.

dhuey

It'd be very aggressive to claim a FMV of only $0.001. As you point out, this might be the liability an airline recognizes, but that's a very different concept than fair market value. The airlines hate mileage brokers, but they are making bone fide offers on miles. I think they provide the most accurate estimate of fair market value. From what I've seen, that's around 1.2 to 1.8 cents per, depending on the airline and the quantity of miles for sale.

dhuey

Do the airlines really claim that they own all of the miles? They sell miles in bulk to the credit card companies. How can they sell something and still own it after the sale?

My understanding is that you own the miles, but their transfer is restricted by contract. This is similar to restricted stock.

mahasamatman

They may not technically be selling the miles - they may word it as a deal where they are selling the right to give the miles to the CC clients.

lancemib

I'm interested to know what everyone would actually claim for taxes (and how to go about documenting the value of miles won). I won a million Worldperks miles in a sweepstakes and the sponsor has them valued at $25,000. Any ideas would be greatly appreciated.

dhuey

Google "sell frequent flier miles" and get quotes from three brokers. Print them out, take the average of the quotes and you've got yourself fair market value. Attach a statement (w/ quotes from mileage brokers) to your tax return explaining that the sponsor's valuation of $25,000 far exceeds fair market value, and that the real FMV is x (probably around $10-16k).

Will the IRS accept this? I don't know, but I think they should and you should fight them if they don't. Relatively few miles change hands at 2.5 cpm. The real market is with the mileage brokers. Yes, that market might be a big breach of contract festival, but it's still a genuine market.

FWAAA

I agree with dhuey's analysis of value.

Miles are certainly worth something (why else would all those crazy mileage runners do what they do if they were not valuable?) but they aren't worth as much as the conservative tax staff at the airline says they are on the 1099 you're issued when you win miles.

The IRS has long argued (with some success) that items carrying a large wholesale to retail spread (like, say, diamonds) are to be valued for gift/estate tax purposes at retail (what you'd have to pay the retailer to buy them) and not at the wholesale value (what the retailer would pay the estate to buy the gems).

So if you win a large enough pile of miles to make it worth their while, the IRS is likely to assert that they are worth the $0.025 or so price that the airlines get when they sell them to individuals (that's roughly AA's public price). Nobody really knows what Citi pays for its billions of AAdvantage miles each year, but most people understand that when you spend hundreds of millions of dollars on miles, you get a price break. So the "right" value is probably somewhere in the middle.