Court Holds Certain Purchases Using Credit Card Rewards Are Taxable

(Parker Tax Publishing March 2021)

The Tax Court held that a couple who acquired rewards from American Express equal to 5 percent of their purchases of prepaid Visa gift cards, money orders, and reloadable debit cards, which were paid to them in the form of statement credits against their American Express bills, realized income in the amount of the rewards relating to the money orders and debit cards, but not the Visa gift cards. The court found that the Visa gift card purchases were for goods and services and therefore the rewards were rebates that resulted in a downward price adjustment of the gift cards; however, rebate treatment did not apply for the purchases of money orders and debit cards because no product or service was obtained with those purchases. Anikeev v. Comm'r, T.C. Memo. 2021-23.

Background

During 2013 and 2014, American Express offered a rewards program known as Blue Cash from American Express Card (i.e., the rewards program). The rewards program paid "reward dollars" to credit card users who made eligible purchases on their American Express cards. Eligible purchases were purchases made on the card for goods and services. Under the terms of the rewards program, eligible purchases did not include, among other items, purchases of any cash equivalents. Under the reward program, a "reward year" comprised 12 billing periods in a row beginning with the first anniversary of the opening of the account. There was no limit on the amount of reward dollars a card user could earn in a reward year.

Konstantin and Nadezhda Anikeev were American Express cardholders in 2013 and 2014. To generate as many reward dollars as possible, the Anikeevs used their American Express cards to buy as many Visa gift cards as they could from local grocery stores and pharmacies. In addition to the values of the gift cards, the Anikeevs were charged service fees for the gift cards of between 0.8 percent and 1.2 percent of the gift cards' face values. The Anikeevs used the gift cards to buy money orders, then deposited the money orders into their bank accounts. When they paid their monthly American Express bills, they received the applicable percentage of the total purchases in reward dollars.

Most of the Anikeevs' total dollars spent with the American Express cards were for purchases of Visa gift cards. They sometimes paid their American Express bills through MoneyGram, a money transfer company. When using MoneyGram, they paid the American Express bill with a reloadable debit card, and MoneyGram would transmit the payment to American Express electronically. The Anikeevs used their American Express cards to purchase the reloadable debit cards that they used to pay their American Express bills, and the purchase of debit cards and reloads also generated reward dollars. On occasion, Mr. Anikeev purchased money orders from Rite Aid with one of the American Express cards, which also generated reward dollars.

In 2013, the Anikeevs' charges totaled $1,219,077. In 2014, they made charges totaling $5,184,033 for Visa gift cards, reloadable debit cards, and money orders. The purchase of money orders with the Visa gift cards provided a means to deposit the amounts charged on the American Express cards into the Anikeevs' bank accounts. The couple typically purchased the money orders with the Visa gift cards but, on some occasions, they bought the money orders directly with their American Express cards. In 2013 and 2014, the Anikeevs deposited a combined $4,028,743 in money orders into their bank accounts.

The Anikeevs redeemed $36,200 in reward dollars as statement credits in 2013 and $277,275 in 2014. On their joint tax returns for 2013 and 2014, they did not report any income from the rewards program. In 2017, the IRS determined that the Anikeevs had unreported income from the Rewards Program and issued notices of deficiency for 2013 and 2014. The Anikeevs challenged the deficiencies in the Tax Court.

Analysis

While gross income is defined broadly under Code Sec. 61, adjustments to the purchase prices of goods or services have consistently been considered nontaxable. In Rev. Rul. 76-96, the IRS addressed the tax treatment of rebates paid by an automobile manufacturer to retail customers and held that the receipt of the rebate by the retail customer did not result in the receipt of gross income. Rather, the rebate was a reduction in the purchase price requiring a downward adjustment in the basis of the automobile.

The IRS argued that, under the cash equivalence concept, Rev. Rul. 76-96 did not apply to the Anikeevs' purchases. Focusing not on the Anikeevs' purchase of gift cards but rather on their later use of the gift cards to purchase money orders to generate deposits to their bank accounts, the IRS contended that the Anikeevs purchased cash equivalents, rather than goods and services that were subject to rebates. Implying that the Anikeevs' purchases should not have qualified for reward dollars, the IRS contended that no purchase price adjustment was possible for the gift cards because the basis of a cash equivalent equals its face value.

The Tax Court held that the reward dollars associated with the Visa gift card purchases were not properly included in income, but the court upheld the inclusion in income of the reward dollars for the direct purchases of money orders and the cash infusions to the reloadable debit cards. The Tax Court observed that the issue in this case rested squarely in the "legal chasm" between the basic principle to broadly define income and the vagueness of the IRS's policy on credit card rewards.

The court pointed out that Visa gift cards are not redeemable for cash or eligible for deposit into a bank account, which is why the Anikeevs used them to buy money orders. In the court's view, the IRS overlooked the benefit provided by allowing a gift card as a substitute for a credit card. The court found that the Visa gift cards are a product that provides the service of being a substitute for a credit card. The court also noted that American Express treated the purchases as eligible for reward dollars. The court said that, whatever the Anikeevs' intent in buying the cards, they paid fees to acquire the cards and the convenience embodied in them.

In the court's view, the reward dollars theoretically reduced the Anikeevs' bases in the Visa gift cards purchased, and the Anikeevs generated proceeds when they converted the cards to money orders. To the extent that the rebates exceeded the fees charged to acquire the gift cards, it seemed to the court that gain was generated similar to the gain that an automobile purchaser would generate if a vehicle for which a rebate was received was sold for more than the purchase price, reduced by the rebate. Thus, the court said, the taxable event would not be the receipt of the reward dollars but instead would be the transformation of the gift cards into cash equivalents that could be deposited into a bank account. The court observed that the IRS did not argue that the Anikeevs should recognize gain on the exchange of the gift cards or debit cards for assets that could be deposited into their bank accounts, but rather took the position that rewards dollars generated ordinary income to the couple when issued by American Express.

In the court's view, the cash equivalency doctrine did not apply to the transactions in this case. According to the court, cash equivalency is used to evaluate the proper timing of income recognition when a taxpayer receives a contractual right to receive payment in the future. The court noted that, under Cowden v. Comm'r, 289 F.2d 20 (5th Cir. 1961), a debt obligation is a cash equivalent where it is a promise to pay off a solvent obligor and the obligation is unconditional and assignable, not subject to set-offs, and is of a kind that is frequently transferred to lenders or investors at a discount not substantially greater than the generally prevailing premium for the use of money.

However, the court found that, unlike the Visa gift cards, no product or service was obtained when the Anikeevs purchased the money orders and added cash to the redeemable debit cards. The court found that the money orders were not properly treated as a product subject to a price adjustment because they were eligible for deposit into the Anikeevs' bank account from the moment acquired. Similarly, the cash infusions to the reloadable debit cards were not product purchases. The court observed that the reloadable debit cards were used for Moneygram transfers, which were arguably a service, but the court found that the reward dollars in dispute were issued for the cash infusions, not the Moneygram transfer fees. Therefore, the court upheld the IRS'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.

For a discussion of the taxability of gains derived from dealings in property, see Parker ¶70,701.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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