Citibank deems frequent-flier miles taxable, but does the IRS?

Frequent-flier miles clearly have value — why else would people want them? But do they also represent taxable income?

Citibank seems to think so. It’s sending tax forms to people who received thousands of miles as a reward for opening a checking or savings account. Those forms value each mile at about 2.5 cents and list the total dollar amount as miscellaneous income.

This is news to tax pros.

“I’ve been practicing for 25 years and I’ve never had an instance where miles have been treated as taxable,” said Gregg Wind, a West Los Angeles certified public accountant.

But he said that because Citi is reporting this as people’s income to the Internal Revenue Service, customers may be on the hook for paying the taxes. “Otherwise,” Wind said, “your chances of being audited could go up.”

As tax time rolls around, the question of whether airline miles are a form of income is something that potentially affects millions of people. Miles are one of the most common rewards doled out by credit card issuers.

Larry Fechter, 66, of Palm Springs was among numerous Citi customers who received a Form 1099 in recent days. He opened a checking and a savings account with the bank last summer after being promised 25,000 American Airlines miles.

“The mileage was a very strong inducement,” Fechter told me.

He said there was nothing in the original sales pitch that warned of the tax consequences of accepting the miles. As such, Fechter said it was a big surprise to get the form in the mail informing him that he has to pay taxes on $645 worth of miles.

If he were in the 28% tax bracket, that would mean a payment of $180.60 owed to Uncle Sam.

Adding insult to injury, Fechter said, his new Citi accounts paid less than $4 in interest on the cash he’d deposited.

“I’m shocked that they want me to pay taxes for mileage points,” he said. “I’ve never had to do that before with any company I’ve done business with.”

And there’s a good reason for that. In 2002, the IRS issued a policy brief noting that because there are “numerous technical and administrative issues” relating to miles, such as how they’re valued and used, the agency “has not pursued a tax enforcement program with respect to promotional benefits such as frequent-flier miles.”

“Consistent with prior practice,” it said, “the IRS will not assert that any taxpayer has understated his federal tax liability by reason of the receipt or personal use of frequent-flier miles or other in-kind promotional benefits attributable to the taxpayer’s business or official travel.”

In other words, the tax man won’t come after you for undeclared miles.

Or will he?

Catherine Pulley, a Citi spokeswoman, cited the 2012 instructions for Form 1099-MISC, which state that income tax must be paid if at least $600 in “prizes and awards” is received.

“The Internal Revenue Code recognizes rewards as taxable income,” she said. “This recognition by the Internal Revenue Code is disclosed to customers prior to their election to participate in the promotion.”

Not so much, actually. Buried in the fine print of Citi’s letter offering the frequent-flier miles, it says only that “customer is responsible for taxes, if any.” That’s not quite the same as saying Citi will be ratting you out to the IRS for receiving hundreds of dollars in miscellaneous income.

So where does the IRS stand on all this? I found the tax agency surprisingly reticent on the matter of miles.

An IRS spokeswoman told me only that the 2002 policy brief “still stands.” She declined to comment on how this squares with the prizes-and-awards provision of Form 1099, or what taxpayers should do in light of Citi’s reporting their airline miles as income.

Wind, the accountant, was stunned by Citi’s defense of reporting miles as taxable income. He said he couldn’t think of any instance in which miles would be given out except as a prize or award.

“This opens up the notion that all miles are taxable,” Wind said.

It does. And it’s insufficient for the IRS to avoid taking a stand and to say only that it won’t go after people for failing to declare their frequent-flier miles.

At the very least, the tax agency needs to clarify what happens when, as in this case, a business declares your miles as income paid to you. What happens if you don’t do likewise?

As I say, this potentially affects millions of people — virtually anyone with airline miles. It’d be nice to know where we all stand.

David Lazarus’ column runs Tuesdays and Fridays. He also can be seen daily on KTLA-TV Channel 5. Send your tips or feedback to david.lazarus@latimes.com