The IRS Loves Those Frequent Flyers

6/4/2014

For fiscal 2014, the IRS expects to collect $3 trillion in taxes: $1.4 trillion in individual income taxes, $1.0 trillion in Social Security and Medicare, $332.7 billion in corporate income tax, $154 billion in transportation and excise taxes, and "just" $15 billion in gift & estate taxes. Three trillion dollars sounds like it ought to be enough to finance the government. But of course it's not. Washington is constantly searching for more change in the national couch cushions. (Value-added tax, anyone? Carbon tax?) And now it looks like they may have found the mother lode. Would you believe they're finally coming after your frequent flyer miles?  

The first frequent-flyer program took off back in 1972. Since then, nearly every airline has launched one, and hotel chains have climbed aboard, too. Loyalty programs are so popular that over half of all credit card purchases made in the U.S. are made with cards tied to loyalty programs. That's especially astonishing when you consider how cramped the airlines have made their seats and how many "junk fees" they've loaded up on — for checked bags, overhead bin space, curbside check-in . . . the list goes on and on.  

The IRS recognizes six kinds of frequent flyer miles, and taxes them according to how you receive them. These include:  

  1. Miles awarded for travel (nontaxable)
  2. Miles awarded for credit card use (nontaxable)
  3. Miles awarded in connection with business travel (nontaxable but mainly because it would be too hard to track)
  4. Miles awarded for opening an account (taxable)
  5. Miles awarded for putting money in a mutual fund (which reduces your tax basis in the fund)
  6. Miles awarded as prizes (taxable)

For the most part, those rules make sense. But now it appears that change is on the radar. Last August, the Service released its 2013-2014 "Priority Guidance Plan" that included a project modifying the accounting rules for loyalty programs. And last month, a group of four major travel associations sent a letter to Treasury Secretary Jack Lew urging him to reject any changes to those rules.  

It may be that changing the way the IRS treats loyalty programs at the airline level doesn't necessarily mean taxing the awards they grant their members. But does anyone doubt that airlines — who now charge for luxuries like pillows and blankets — will pass any new tax costs through to passengers? (If we're lucky, the new tax will arrive as late as your last flight did!)