The decision by Citibank to count rewards miles as taxable income has drawn the attention of a U.S. Senator, who calls on the bank’s chief executive to relieve customers of this tax burden that he says is not required by the IRS – but it is.

The Internal Revenue Service has addressed the issue that angered Citibank (NYSE: C) customers, who received tax forms for rewards miles awarded to them for opening new accounts.

“When frequent-flier miles are provided as a premium for opening a financial account, it can be a taxable situation subject to reporting under current law,” said Michelle Eldridge, an IRS spokeswoman.

There is little of a surprise that the IRS took this stance since Publication 550 already noted that financial institutions can report gifts that were given for opening accounts.

Citibank sent Form 1099-MISC to customers who took advantage of a promotion in the summer of last year that offered 25,000 American Airlines frequent flier miles.

The bank reserves the right to report the cost of these “gifts”. Since Citibank valued each mile at 2.5 cents, the total value of the rewarded miles is $625, reaching the IRS’s mandatory $600 reporting threshold.

Senator Enters the Fray

Even though Citibank followed the rules, the news caught the attention of one U.S. Senator.

In a letter to Citibank CEO Vikram Pandit, Ohio senator Sherrod Brown asked the bank to drop the tax burden it has put on affected customers.

“Reporting frequent-flier miles as taxable income is inconvenient to consumers, raises their anxiety unnecessarily, and is not required by the law,” Brown writes in the letter. “I urge Citibank to halt this practice.”

Arbitrary Valuation

The Senator also questions the valuation of each frequent flier mile. In the American Airlines AAdvantage®membership program, there are no options to redeem miles directly for cash.

The lowest miles redemption award for airfare is a one-way economy class ticket within the continental United States, which requires 12,500 miles (25,000 miles round trip). Citibank’s valuation would put that round trip airfare at $625.

However, depending on the destination and travel class, it is possible to spend fewer miles for closer destinations while the miles can be worth more when flying in a better travel class or to farther destinations. Therein lies the difficulty of placing a strict cost basis for each mile.

Regardless of the math, Citibank may still send out tax forms if the miles didn’t exceed the $600 reporting threshold. And, Brown is calling out against it – to help out struggling American families.

“The last thing Citibank should be doing is creating baseless fear in middle class families, or placing a nonexistent tax burden on the backs of families who are already struggling to make end meet,” Brown added.

Despite the well-intentioned position taken by the Ohio senator, Citibank played by the rules set forth by the IRS.

Publication 550 states that the value of the gifts is “determined by the cost to the financial institution.” Rather than fight the legitimacy of the tax burden, it may be worth challenging the valuation of the miles.

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  • Sunshine25

    I am realizing that valuation will depend on what kind of miles or points are issued. If these rewards are categorized as “income” (e.g. no spend required to earn the reward), then you still have to see if they are AAMiles, ThankYou Points, etc. I would like to see 1099-MISC issued at the rate the customer can redeem them. I suppose with AAMiles, you would have to find a fare you can buy for 25,000 AAMiles or some sort of similar equivalent. For ThankYou points, I think 0.7 cents per point is reasonable ($175 for 25,000 points) since that is what I can redeem for on their web site.

    As I understand it, a 1099-MISC can be issued for income less than $600, but it is not required. If CitiBank wants to declare the business expense, then customers would have to declare the 1099-MISC on their income tax return.

    • Simon Zhen

      I’ve tried a bunch of ways to find some sort or reasonable fare equivalent for 25,000 AA miles and it is very difficult given the confusing pricing model. Fares vary by travel class, travel dates, airline choice, and number of stops – too many factors that impact prices.

      To add to the confusing, for some redemption flights, the destination doesn’t matter. For example, for flights in the continental U.S., you can fly from NY to Miami or Los Angeles and it’ll cost the same amount of points

      When paying regularly, it is a big difference.

      • What is the dollar value of the fare at the time it was purchased and how much many points were used to redeem it. That seems like a fair way to calculate… The danger with valuating at a fixed cost of 1 cent per point is that the value of the dollar may drop over time and we may be burdened with conversions that are neither fair nor correct. It is a little more on AA’s part, but once you build the calculation report, the report would not need involvement to maintain.