Award Points: What’s Includable in Taxable Income?

23 Sep 2014

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Award Points: What's Includable in Taxable Income in Tampa, Florida?

In its attempts to narrow the “tax gap” between what taxpayers report and what they legitimately owe, the IRS is cracking down on taxpayers who fail to report taxable income. For one married couple, the IRS claimed the value of an airline ticket received by redeeming “thank you” award points should be included in gross income, similar to interest income. The U.S. Tax Court agreed.

Employers Should Consider Tax Consequences of Holiday Gifts

With the holidays coming up, it’s a good time to review the tax rules involved in giving gifts to employees. Here are six general rules involving the taxation of gifts, awards, and incentives:

Monetary prizes, awards, bonuses and gift certificates, including achievement awards, are generally considered taxable compensation that’s subject to federal and state income tax withholding, unemployment tax and FICA taxes.
Prizes, bonuses, and awards that involve goods or services, such as a vacation trip for meeting a sales goal, also generally result in taxable income.
“Tangible personal property” awarded to employees to recognize the employees’ length of service or safety achievement generally is not taxable (see below).
The term “tangible personal property” doesn’t mean cash or gift certificates. Although the definition of “tangible personal property” is unclear, most tax advisers take the position that certificates and other awards redeemable for merchandise — such as points and cards with point values — are taxable. One exception: If the merchandise is given as an employee achievement award and meets IRS rules.
Awards and gifts of minimal value, such as a holiday turkey, generally fall under the IRS’s de minimis rule and are not taxable. That rule says if an employer provides an employee with a product or service that costs so little that it would be unreasonable for the employer to account for it, the value is not taxable income. (Cash awards and gift certificates redeemable for cash are not included under the de minimis rule.)
The value of holiday gifts, such as merchandise or tickets to sporting events, in excess of the de minimis amount is taxable income.

Tax-Free Employee Achievement Awards

The value of employee achievement awards can be excluded from taxable income. However, the award must involve something other than cash, a gift certificate, or cash-equivalent item, and must be given for length-of-service or safety achievement.

The amount an employee can receive tax free is limited to the employer’s cost and can’t exceed $1,600 ($400 for awards that aren’t qualified plan awards) for all awards the employee receives during the year. In addition, the employer must make the award as part of a meaningful presentation. The tax-free exception does NOT apply if:

The length-of-service award is for less than five years of service or if the employee received another length-of-service award during the year or the previous four years.
The safety achievement award is given to a manager, administrator, clerical employee, or other professional employee.
More than 10 percent of eligible employees previously received safety achievement awards during the year.

Redemption of “Thank You” Points is Taxable

Parimal Shankar was a bank customer who was awarded “thank you” points by the institution for maintaining certain balances in his account. He redeemed those points for an airline ticket in 2009. The bank reported the points redemption to the IRS and Shankar on a Form 1099-MISC. The reported value of the tickets was $668.

The taxpayer and his spouse didn’t report this income on their 2009 tax return. But the IRS included the fair market value of the tickets in the couple’s gross income. The taxpayers disputed this change, arguing that Shankar knew nothing about the bank points and received no award.

The Tax Court noted that the term “gross income” has been broadly interpreted. The IRS includes in gross income “all income from whatever source derived,” even if no cash changes hands. The court opinion states that gross income includes “instances of undeniable accessions to wealth, clearly realized, and over which the taxpayers have complete dominion.”

The court also noted that the taxpayers had ample time between their receipt of the bank’s records and the trial to investigate and show the court that it was in error. They failed to do so, however.

The court gave more weight to the bank’s records showing Shankar’s receipt of an award than it did to his testimony to the contrary. The Court proceeded on the assumption that it was dealing with a premium for making a deposit into, or maintaining a balance in, a bank account.

In other words, the “thank you” points were given in exchange for the use (deposit) of Shankar’s money — similar to interest income. In general, the receipt of interest constitutes the receipt of an item of gross income under the tax code. (Parimal H. Shankar and Malti S. Trivedi v. Commissioner, 143 TC No. 5, August 26, 2014)

Reviewing the Rules

Many people are surprised by the outcome of this case — and are unaware of the IRS’s broad interpretation of what’s includable in gross income. Most people know that wages, salaries, interest, dividends, tips and commissions must be reported as income on their tax returns. But the tax code requires taxpayers to report all income from any source and any country unless it’s explicitly exempt. There may be taxable income from certain transactions even if no money changes hands.

Here are four lesser-known types of income that are includable in gross income on your Form 1040:

Awards, prizes and contest winnings. The cash value of a prize or an award, such as winnings from a random prize drawing or beauty contest, must be included on the tax return as taxable income, with certain exceptions.
Gambling proceeds. Gambling income — including winnings from lotteries, raffles, horse races, poker tournaments and casinos — is fully taxable and must be reported on Form 1040, even if a W-2G isn’t issued. It includes cash and the fair market value of prizes, such as vehicles and trips. Taxpayers may deduct losses only if they itemize deductions. And gambling losses deducted can’t exceed gambling income reported on the tax return.
Cash earned from side jobs. Income earned through the taxpayer’s business, as an independent contractor or from informal side jobs, is self-employment income. It’s fully taxable and must be reported on Form 1040. A common misconception is that if a taxpayer does not receive a Form 1099-MISC or if the income is under $600 per payer, the income isn’t taxable. There’s no minimum amount that a taxpayer may exclude from gross income, however, even if the client forgets to issue a Form 1099-MISC.
Barter exchanges of goods or services. Bartering is an exchange of property or services. The fair market value of goods and services exchanged is fully taxable and must be included on Form 1040 in the income of both parties in the year in which the taxpayer received the goods or services. An example of bartering is someone doing computer repair work for a child care provider in exchange for babysitting services.

Consult with Your Tax Pro

Most people are honest and want to pay their fair share of taxes. But they may need a refresher on what constitutes taxable income. If you’d like more information about which transactions to include in gross income on your Form 1040 — including the redemption of bank, credit card or frequent-flier points — contact our office at 727-894-1040.

About the Author

McClanathan, Burg & Associates, LLC. is a full service accounting firm. Our team members provide services including: Tax, Audit, Assurance and Accounting, Estate and Trust, Forensic Accounting, Litigation Support and Business Valuation.