When Loyalty Programs Become a Taxing Issue and What to do About it

Jul 11, 2012

Benjamin Franklin may have been spot on when it came to his observations about death and taxes being two of life’s great certainties. But even he, in all his wisdom, couldn’t have imagined the modern burdensome US tax code. Nor could he have envisioned today’s lively debate over what can and cannot be taxed – especially as it relates to loyalty programs and loyalty program providers.

At last check, according to the National Taxpayers Union, a taxpayer advocacy group, the current US tax code is a staggering 3.9 million words and has grown by 102,000 in less than two years. Already seven times longer than Tolstoy’s War and Peace, there’s a possibility that thanks to Citibank and a class action lawsuit filed in February, that’s it’s going to get a little bit longer.

Earlier this year, Citibank customers’ Bertram Hirsch and Igor Romanov sued the financial institution on the grounds that it used unfair and deceptive trade practices by not fully disclosing that frequent flyer rewards offered as a “gift” (incentive) for opening a checking account could be taxed. The promotion, which amounted to as much as 40,000 miles, has now ended up costing the pair an estimated $350 – or three and a half Benjamins.

While the current tax code views most credit card loyalty programs and earned rewards as akin to a gift, (or rebate or discount) and therefore not taxable, IRS spokeswoman Michelle Eldridge has said: “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.”

Citi says that its rewards program clearly states that the bank may send a miscellaneous income tax form to participants for the acquisition of points. They’re playing by the rules.

My position on this is two-fold. First, considering the onerous tax code and its estimated $228.4 billion drain on the US economy, it’s unlikely the IRS will reverse its stance that most loyalty program rewards are not taxable. That said, the lawsuit does open the door for the expanded taxation of what I’ll call “incentivized entrance” or startup rewards into a loyalty program across multiple verticals.

Clearly this is a taxing issue. Kobie has a foundational belief and commitment to driving a quality customer experience to both our clients and their customers. Beyond offering appealing benefits and rewards that promote customer loyalty and engagement with our clients’ brands; and beyond the customer awareness and insights we bring to our clients – operational transparency regarding program rules is key. If program entrance premiums are taxable, then it’s our industry’s job to present that information plainly and clearly, either to our client business or through proper consent, to loyalty program members directly.

Surprise and Delight = Good!

Surprised Taxes and 1099s = Bad!

As a point of clarification, it’s also Kobie’s position that 1099s are appropriate for employees, sales representative and channel incentive programs that reward members for their sale of products and services; thereby providing additional non-taxed compensation. Awarding for the sale of a product or service – above and beyond normal compensation has always been taxed. However, consumers or end-users who receive loyalty points/credits/miles/discounts/rebates for their purchases of a brand’s product or service should continue to exist in a tax-free world. With that said, we certainly understand Hirsch and Romanov’s belief that the bucket of miles they received for opening and initially using their new Citi cards should not carry a tax burden.

So is the tax code about to get longer? Probably. But in a refreshing change the IRS is likely to clarify some taxable and non-taxable items rather than confuse. I think even Ben Franklin himself would be glad to hear that.