IRS Sets Sights on Frequent Flyer Miles, Hotel Points

Just in time for your summer vacation, the IRS is getting ready to toughen the tax treatment on frequent flyer miles and hotel loyalty reward programs.

The IRS announced in 2002 that it wouldn't try to go after individuals for income taxes on frequent flyer miles or hotel loyalty points earned on company-paid business trips.  Yet the temptation to wring some tax revenue out of the vast non-dollar economy of Starwood Preferred Guest Starpoints, Marriott Rewards points, American Airlines AAdvantage miles, Delta Skymiles, and so on is apparently so great that that the government just cannot resist.

Sure enough, the Tax Foundation, a research group that tracks tax issues, flags a recent post on the View From the Wing blog that runs under the provocative headline, "The IRS Looks To Be on the Verge of Imposing a Big Tax Burden on Loyalty Points."

The IRS's plans are vague, but they have airlines and hotel owners concerned enough about the issue that they reportedly sent a letter to Treasury Secretary Jacob Lew. "The IRS' proposal to alter the tax treatment of loyalty programs will impose a significant new tax on existing and future loyalty points that travel customers enjoy and rely upon," said the letter, according to a report in Politico. "Any change or clarification of loyalty program accounting should be made through the legislative process, not IRS promulgation." 

Frequent flyer mile fanatics got a wake-up call on the issue back in 2012 when Citibank sent IRS Forms 1099, documenting "miscellaneous income," at a rate of 2.5 cents a mile, to customers who had signed up for an American Airlines-branded credit card and gotten 40,000 AAdvantage miles as a bonus. It was an unpleasant surprise to cardholders who thought they were getting a free trip, not an unwanted extra tax bill.

The frequent flyer flap underscores several policy points that are worth keeping in mind.

If the government imposes tax rates that are high enough, people will do what they can to get around them. Frequent flyer and other loyalty programs did not arise as a way around payroll and income taxes. But the fact that the rewards are generally tax free to the recipient makes them that much more attractive to all concerned than a hypothetical alternative under which a business pays a slightly lower fare or room rate for reward-program-free-travel, then passes along the savings to employees in the form of higher taxable wages.

If something is working basically well, chances are the government will come up with a plan to change it and make it worse. Part of that is because there are differences in culture between the private sector and the government sector. Government ethics rules dictate that frequent flyer miles racked up by government employees flying on government business are government property, so the pleasure of a point-based vacation is unknown to many bureaucrats.

There's a monetary policy angle, too: Americans who keep large balances of unused American Express Membership Rewards points, or airline or hotel points, are not all that different from those who choose to buy gold or Bitcoins. They are choosing to store value in something other than U.S. dollars.

And there's an inequality angle: All those statistics on income inequality and the lagging middle class have a hard time accounting for non-monetary perks like the value of a free vacation earned while traveling on business.

Finally, when the government is spending so much more than it takes in, the pressure rises for Washington to dream up new items to tax, or to raise taxes on.

There seems to be no end to it. President Obama raised taxes on tanning salons, medical devices, and individual income to pay for ObamaCare, and on cigarettes to pay for an expansion of Medicaid. In a deal with Republicans after the 2012 election, he raised taxes on income and on capital gains, then came back with a plan to raise taxes by another trillion dollars over ten years. If anyone balks at paying, Senator Schumer has a plan to turn those who owe taxes over to private collection agencies.

Maybe frequent flyers will prove a more formidable political force than smokers, tanning salon owners, or medical device manufacturers. If not, the time to book that free ticket may be sooner rather than later, at least if you want to avoid having to use those miles to buy an extra seat on the plane for the tax man.