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Who Knew? Reward Points and Rebates May Increase Your Freelance Tax Bill

non-deductiible employee expenses

What’s not to love about credit card rewards, purchase incentives and manufacturer rebates? A potentially higher tax bill for one thing. If that’s news to you, you aren’t alone. While many of us love to collect reward points, get cash back or use travel miles as a perk for purchasing with a credit card or buying a specific item, we don’t necessarily think that the IRS or state tax authorities are in the know—or expecting us to claim them as income. Yet they are. That’s why before you sign up for any new reward program or make a purchase to score a sweet bonus, you should understand how they might impact you from a tax perspective:

Post-purchase perks are usually tax-free. The types of rewards and the way in which you receive them determine whether they are considered taxable by the Internal Revenue Service (IRS). In general, if spending is required prior to you receiving a reward, the IRS tends not to consider the value as taxable income. This is the case for many rewards, like cash back programs from credit card companies, which are usually considered to be a discount rather than income in the eyes of the IRS.

Once you have earned your credit card or other loyalty program rewards, you can redeem them for gift cards, gift certificates or other items of value without having to claim them as income. The IRS still considers the redemption of rewards to be a discount on purchases rather than taxable income.

When does a bonus become a tax burden? Generally, when you are offered an incentive prior to doing any business with a company the IRS considers it part of your taxable income. For example, if you sign up for a credit card or a bank account and receive a significant cash bonus or other incentive (additional travel miles or tangible gifts) for doing so, you need to claim the value as taxable income on your state and federal taxes. This applies whether or not you receive a 1099-MISC form from the company which bestowed a bonus on you.

Be aware that in some states credit card companies are required to report cash payments made to their cardholders to both the state taxing authority and to the IRS which means your income reporting may be under additional scrutiny.

Rebates generally reduce deductible business expenses. It’s always a good idea to have one credit card that you use for all your business expenses to keep them separate from your personal expenses. The same tax rules about credit card rewards and the other incentives you receive for making purchases as outlined above apply to business use as well. However, there is one other thing to note—the IRS rules state that the value of points earned on business purchases as well as any rebates you receive after-the-fact should be subtracted from the cost of said purchases, effectively lowering the tax-deductible amount.

Another thing to keep in mind: the IRS has become very sophisticated at tracking income provided to cardholders from credit card companies and other providers. This means that whether you are reaping rewards from making a credit card purchase, opening a bank account or taking advantage of a post-purchase rebate, you want to make sure that you are not subjected to a tax penalty because you failed to report your gains appropriately.

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Jonathan Medows, CPA

Jonathan Medows is a certified public accountant licensed in New York, New Jersey, Maryland, and Pennsylvania. He is also a recognized expert in taxation for freelancers and the self-employed—often tapped for his expert knowledge and perspective on self-employment taxation by national and regional publications such as The New York Post, BusinessWeek, Forbes taxation blog, WebCPA, CPA Practice Advisor, and others. You can read some of Jonathan’s press coverage here.

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