There’s a tax ruling which will be of interest for anyone who manufactures spend (and even those who don’t) as the IRS was trying to get more than $300,000 worth of rewards from American Express classed as taxable income for a couple who manufactured spend.
You can read the judge’s filing here which also contains a summary of the IRS’s case against the couple. As a quick summary:
- 2013
- The couple spent $1,208,376 on the following transactions:
- Visa gift cards
- Reloadable debit cards
- Money orders
- They redeemed $36,200 in Reward Dollars
- The couple spent $1,208,376 on the following transactions:
- 2014
- The couple spent $5,184,033 on the following transactions:
- Visa gift cards
- Reloadable debit cards
- Money orders
- They redeemed $277,275 in Reward Dollars
- The couple spent $5,184,033 on the following transactions:
That means that the couple redeemed a total of $313,475 in Reward Dollars which wasn’t included as income on their tax returns. The IRS somehow got wind of this and issued a notice of deficiency to the couple stating that they owed an additional $9,928 in taxes for 2013 and $93,845 for 2014, so a total of $103,773 extra due in tax – ouch!
Before I go any further, it’s important to note that I’m not a lawyer and am far from being any kind of tax expert. It would therefore be worth discussing with your CPA if anything arising from this could affect your taxes.
While this all sounds like bad news, my reading of this is that it’s nowhere near as bad as it could have been. Although the IRS was seeking $103,773 in additional tax being paid by Konstantin Anikeev and Nadezhda Anikeev, it doesn’t look like the judge has ruled in their favor entirely.
It was Mr & Mrs Anikeev who brought the case to court against the IRS after receiving the notice of deficiency. That makes the Anikeevs the petitioners and the IRS the respondents which is important to note when reading the filing, because if you incorrectly assume the Anikeevs are who are being referred to as the respondents, that completely changes the context.
One of the first things to note is that the IRS wasn’t trying to claim that the couple’s ~$6.4 million of spend was taxable. Rather, the Reward Dollars they received from American Express on that spend was deemed by the IRS to be taxable.
The judge appears to have ruled both for and against the IRS depending on the types of transactions. As mentioned earlier, the Anikeevs used their Amex cards for three types of transactions:
- Visa gift cards
- Reloadable debit cards
- Money orders
What’s also important to note at this point is that there were two types of transactions involving money orders – money orders purchased using Visa gift cards and money orders purchased directly with their Amex cards at Rite Aid. This is a key distinction in the judge’s ruling.
The judge’s ruling states the following with regards to transactions where the couple purchased Visa gift cards and then redeemed them for money orders:
In conclusion, we hold that the Reward Dollars associated with the Visa gift card purchases were not properly included in income.
Upon first glance, that could be interpreted that the Anikeevs should’ve included the Reward Dollars earned as income on their tax returns. However, the context of this part of the ruling is the judge addressing how the IRS has calculated income in their notice of deficiency. As a result, the judge’s ruling seems to be that the IRS’s calculations of the Anikeevs’ income improperly included Reward Dollars earned from Visa gift card purchases and therefore weren’t subject to income tax. (n.b. While I’m not a lawyer, a lawyer reached out to Frequent Miler to advise that this is his assessment of this part of the ruling too.)
The other types of transactions – Moneygram bill payments via reloadable cards funded by their Amex cards and money orders purchased directly with their credit cards (rather than via Visa gift cards) – are regarded differently. That’s because the judge regarded Visa gift cards as a product which weren’t redeemable for cash, whereas bill payments and money orders obtained directly by paying with their credit card (rather than having a Visa gift card as a middleman middleproduct) were cash equivalents. The ruling therefore states that:
The money orders are not properly treated as a product subject to a price adjustment because they were eligible for deposit into petitioners’ bank account from acquisition. Similarly, the cash infusions to the reloadable debit cards were not product purchases. The reloadable debit cards were used for Moneygram transfers, which are arguably a service. However, the Reward Dollars in dispute were issued for the cash infusions, not the transfer fees. Therefore, we uphold respondent’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.
Unfortunately the filing doesn’t provide a spending breakdown between credit card > Visa gift card > money order transactions and reloadable debit card bill payments and direct credit card > money order transactions. It’s therefore not clear how much the couple owes the IRS; if the majority of the transactions involved Visa gift cards, that would greatly reduce their liability.
It takes a little while to read, but I’d recommend reading the filing as some of the judge’s comments are quite amusing and, in what’s presumably understated judge-speak, seems impressed by the Anikeevs’ shenanigans. For example:
Petitioners’ aggressive efforts to generate Reward Dollars have created a dilemma for respondent which is largely the result of the vagueness of IRS credit card reward policy. Petitioners clearly acquired economic benefits by cleverly and relentlessly manipulating the Rewards Program. Their actions never offended American Express and had Mr. Anikeev not been so successful in his efforts he likely would have been ignored by the IRS.
Based on this ruling, it seems like rewards earned from purchases of Visa gift cards which are then converted to money orders are safe from being taxable right now (but again, consult your CPA – my impression is in no way tax advice). Other types of manufactured spending techniques which don’t involve the purchase of a product or service on the other hand could come under more scrutiny going forward.
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