A taxpayer found a way to maximize benefits in an extreme way in an American Express credit card rewards program, so much so that the IRS looked to impose a tax on the gains in the case of Anikeev v. Commissioner, TC Memo 2021-23.[1] But the Tax Court found that the IRS’s years of informal guidance created a situation where most of the benefits were not taxable—at least not in the way the IRS was attempting to tax the benefits in the case.

Facts of the Case

Konstantin Anikeev had a Blue Cash American Express credit card. American Express established a rewards program that had the following provisions:

During 2013 and 2014 American Express offered a rewards program known as Blue Cash from American Express Card (Blue Cash Rewards Program or Rewards Program). The Blue Cash Rewards Program paid Blue Cash Reward Dollars (Reward Dollars) to credit card users who made eligible purchases on their American Express cards. The number of Reward Dollars that a card user could be awarded pursuant to the Blue Cash Rewards Program was based on a percentage of the dollar amount of the card user’s eligible purchases. Eligible purchases were purchases made on the card for goods and services minus returns and other credits.

Pursuant to the terms of the Blue Cash Rewards Program, eligible purchases did not include: (1) fees or interest charges, (2) balance transfers, (3) cash advances, (4) purchases of traveler’s checks, (5) purchases or reloading of prepaid cards, or (6) purchases of any cash equivalents. For purposes of the Blue Cash Rewards Program, a Reward Year comprised 12 billing periods in a row beginning with the first anniversary of the opening of the account.

For the first $6,500 of purchases in each Reward Year petitioners received Reward Dollars equal to 1% of everyday purchases and 0.5% of all other eligible purchases. For purchases in excess of $6,500 petitioners received Reward Dollars equal to 5% of everyday purchases and 1% of all other eligible purchases. The Blue Cash Rewards Program defined everyday purchases as eligible purchases made in the United States at: (1) supermarkets (superstores and warehouse clubs are not considered supermarkets), (2) gas stations for purchases of $400 or less of gasoline (superstores, supermarkets, and warehouse clubs that sell gasoline are not considered gas stations), and (3) select major drugstores.

Reward Dollars earned during a billing period became available for redemption after the subsequent billing period if the card was in good standing. American Express treated all of petitioners’ purchases in 2013 and 2014 as qualifying for Reward Dollars. The first page of each billing statement included a statement of Reward Dollars earned during the billing period, and the last page included a Reward Dollars summary that described Reward Dollars earned and redeemed during the billing period. Card users could redeem Reward Dollars for Amazon gift cards or as credits on their American Express card balances (statement credits). There was no limit on the amount of Reward Dollars a card user could earn in a Reward Year.[2]

Mr. Anikeev undertook a program to maximize (and I mean really maximize) rewards in this program by purchasing gift cards, something American Express did not object to:

To generate as many Reward Dollars as possible, petitioners used the 1005 Card and the 1001 Card (American Express cards) to buy as many Visa gift cards as they could from local grocery stores and pharmacies. In addition to the values of the gift cards, petitioners were charged service fees for the gift cards of between 0.8% and 1.2% of the gift cards’ face values. They used the gift cards to purchase money orders and were charged service fees for the money orders between 0.07% and 0.33% of the dollar amounts of the money orders. They deposited the money orders into their bank accounts. The fees associated with a $500 gift card and a related money order purchase were between $6 and $7.

Upon a payment of their monthly American Express bills, they received the applicable percentage, either 1% or 5%, of the total purchases in Reward Dollars that they could use for a statement credit or redeem for Amazon gift cards. Most of petitioners’ total dollars spent with the American Express cards were for purchases of Visa gift cards.

On occasion petitioners paid their American Express bills through MoneyGram, a money transfer company offering its services in participating Walmart stores. When using MoneyGram, petitioners paid the American Express bill as well as the applicable service fee with a reloadable debit card, and MoneyGram would transmit the payment to American Express electronically. Petitioners used their American Express cards to purchase the reloadable debit cards that they used to pay their American Express bills, and the purchase of debit cards and reloads also generated Reward Dollars.[3]

The taxpayer, working with an account with a credit limit of $35,000, managed to create a very large amount of rewards:

Petitioners redeemed $36,200 in Reward Dollars as statement credits in 2013 and $277,275 in 2014.[4]

Tax Issues

The taxpayers did not report these amounts as income on their tax returns for the years in question. As the opinion notes, the IRS concedes that its position is that generally such rewards are not income:

At the outset of the trial of this case, respondent’s counsel said: “And it’s a long-standing IRS policy, Mr. Sklarz is right, long-standing IRS policy is that card rewards are not taxable. And the rationale for that is that the reward itself acts as a discount on whatever property or services are being purchased by the consumer.”

This policy reflects the recognition that a taxpayer who avails himself or herself of a discount in acquiring goods and services has no accession to wealth. That taxpayer has retained more of his or her wealth than a taxpayer who pays full price for the same good or service, but that taxpayer has no additional income; he or she simply has reduced consumption. Although as Benjamin Franklin wisely observed, “[a] penny saved is two pence clear” (which became known more colloquially as “a penny saved is a penny earned”), the income tax law imposes a tax only on the future penny earned, not on the current penny saved.[5]

However, the IRS attempted to argue that this case was different. The opinion quotes the IRS summary of its position:

Generally, when a payment is made by a seller to a customer as an inducement to purchase property, the payment does not constitute income but instead is treated as a purchase price adjustment to the basis of the property. Pittsburgh Milk Co. v. Commissioner, 26 T.C. 707 (1956); Rev. Rul. 76-96, 1976-1 C.B. 23. In this case, however, petitioners did not purchase goods or property to which a basis adjustment may apply. Rather, they purchased cash equivalents, in the form of Visa gift cards, Reloads for the Green Dot card, and money orders, to which no such adjustment can apply. See Cowden v. Commissioner, 289 F.2d 20, 24 (5th Cir. 1961) (setting forth the cash equivalence doctrine); Bixby v. Commissioner, 58 T.C. 757 (1972) (cash equivalents have basis equal to face value). As a result, the Reward Dollars paid to petitioners as statement credits for the charges relating to cash equivalents are an accession to wealth and income to petitioners under I.R.C. § 61.[6]

However, the taxpayer cited an IRS interrogatory response to note that the IRS position fundamentally comes down to not taxing the reward that is generated by the purchase of a product—in this case the gift cards. As the taxpayer’s statement points out:

The IRS [Internal Revenue Service] proposes to tax Mr. Anikeev’s rewards points because he did not earn them by acquiring goods or services. The IRS’ position is: “rewards generated where no goods or services are purchased are taxable. Thus rewards generated by the purchases of gift cards and then the purchases of money orders, without the purchase of any goods or services are taxable.” The manner of purchase of something, however, does not constitute an accession of wealth. Applying I.R.C. § 61, the rewards points would be taxable when received, not based on how the gift cards were later used. What Mr. Anikeev later used the gift cards (which are a product, given that they have a Universal Product Code) to purchase should not matter.[7]

The Tax Court mainly sides with the taxpayer, finding the IRS created the issue with a vague policy on how to tax such rewards:

This case rests squarely in the legal chasm between the basic principle to broadly define income and respondent’s own policy. 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. However, the scale of his success in acquiring rewards makes this case an extreme test of the longstanding nontaxability of credit card reward programs. To avoid offending his own longstanding policy respondent seeks to apply the cash equivalence concept. As we will explain herein we do not find it is a good fit.[8]

The Court notes this policy has grown out of a single Revenue Ruling issued to deal with rebates offered on the purchase of cars by automobile manufacturers:

Rev. Rul. 76-96, supra, is a key link in the chain of IRS reasoning on credit card rewards. It concerned the tax treatment of rebates paid by an automobile manufacturer to qualifying retail customers who purchased its automobiles. Rev. Rul. 76-96, supra, held that the receipt of the rebate by the retail customer did not result in the receipt of gross income. Rather, the rebate was a reduction in the purchase price, requiring a downward adjustment to the basis of the automobile pursuant to section 1012.[9]

The Court noted early in the opinion that the IRS was not asserting that there was a taxable exchange when the taxpayer converted the gift cards to cash equivalents through the purchase of money orders (which is how they got the cash to pay off the purchases charged to their AMEX card that eventually created the rewards), but rather arguing that buying gift cards with the intent not to buy goods or services rendered the rewards points taxable—but the Tax Court wasn’t buying the concept:

Respondent’s assertion of the inclusion in income of Reward Dollars turns on the ultimate use of the Visa gift cards. Because petitioners used the Visa cards to buy money orders to generate deposits to their bank accounts, respondent contends that petitioners have purchased cash equivalents. Visa gift cards are not redeemable for cash or eligible for deposit into a bank account, which is why petitioners used them to purchase money orders. The benefit provided by allowing a gift card as a substitute for a credit card is conveniently overlooked in respondent’s denial of “product” treatment to the gift cards, which depends completely on petitioners’ failure to purchase goods or services. Providing a substitute for a credit card is a service via a product which is commonly sold via displays at drug stores and grocery stores. American Express treated such purchases as eligible for Reward Dollars throughout the years at issue. Respondent ignores this, implying that the purchases should not have qualified for Reward Dollars. He points to petitioners’ intended use of the cards, but whatever petitioners’ intent they paid fees to acquire the gift cards and the convenience embodied in them. The fees were not a function of petitioners’ or any customers’ intended use of the gift cards.[10]

The opinion rejected the IRS’s view that these cards were cash equivalents in the manner the Court had found in the case of Felt v. Commissioner:

The most recent case respondent cites regarding cash equivalents is Felt v. Commissioner, T.C. Memo. 2009-245. In Felt, we described the application of the cash equivalent concept to a note that was a promise to pay by a solvent obligor. Id., slip op. at 14-15. Reward Dollars petitioners received were not notes, but they were commitments by American Express to allow petitioners credits against their card balances. Respondent’s analysis leaps to the cash equivalence position without an analysis of the origin of the Reward Dollars. Respondent’s position holds weight only if the Reward Dollars were not an effect of the purchase price of goods and services. Otherwise, all Reward Dollars would be taxable as cash equivalent income. American Express offered the Rewards Program as an inducement for card holders to use their American Express cards. For his own reasons respondent has made a conscious choice to avoid the application of a rebate analysis to the taxability of the cash rewards as a reduction of basis. In conclusion, we hold that the Reward Dollars associated with the Visa gift card purchases were not properly included in income.[11]

The Court, however, found that when the taxpayer purchased money orders directly or reloaded debit cards with the American Express card, those rewards were taxable.

However, petitioners’ direct purchases of money orders and reloads of cash into the debit cards using the American Express cards presents a different question from the purchase of Visa gift cards. The Visa gift cards have product characteristics. They provide a consumer service embodied in a simple plastic card for convenience. The Visa gift cards are not redeemable for cash, but the money orders purchased with the American Express cards and the infusion of cash into the reloadable debit cards are difficult to reconcile with the IRS credit card reward policy. No product or service is obtained in these uses of the American Express cards other than cash transfers. 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.[12]

A Mess of the IRS’s Making

As we’ve commented recently, the IRS has shown a strong preference for issuing guidance in forms other than regulations or even Revenue Rulings. In this case, we had decades of a rather vague IRS policy on the issue that was derived from a single IRS Revenue Ruling looking at a very specific transaction (purchase of a car).

The Tax Court lectures the IRS on the folly of pursuing issues in this rather haphazard fashion, noting:

We note that the above holdings are not based upon the application of the cash equivalence doctrine but rather the incompatibility of the direct money order purchases and the debit card reloads with the IRS policy excluding credit card rewards for product and service purchases from income. These holdings are based on the unique circumstances of this case. We hope that respondent polices the IRS policy in the future in regulations or public pronouncements rather than relying on piecemeal litigation.[13]

As well, the Court pointed out more than once that the IRS likely would have succeeded if they had gone after the exchange of the gift cards for what clearly were cash equivalents as the taxable event.

But in the final analysis the taxpayer effectively was able to generate nearly $300,000 of cash on which no tax was paid.

[1] Anikeev v. Commissioner, TC Memo 2021-23, February 23, 2021, https://www.taxnotes.com/tax-notes-today-federal/individual-income-taxation/tax-court-determines-tax-treatment-credit-card-cash-rewards/2021/02/24/2zfqp (retrieved February 26, 2021)

[2] Anikeev v. Commissioner, TC Memo 2021-23, February 23, 2021, pp. 3-5

[3] Anikeev v. Commissioner, TC Memo 2021-23, February 23, 2021, pp. 7-8

[4] Anikeev v. Commissioner, TC Memo 2021-23, February 23, 2021, p. 10.

[5] Anikeev v. Commissioner, TC Memo 2021-23, February 23, 2021, p. 13

[6] Anikeev v. Commissioner, TC Memo 2021-23, February 23, 2021, p. 11

[7] Anikeev v. Commissioner, TC Memo 2021-23, February 23, 2021, p. 11

[8] Anikeev v. Commissioner, TC Memo 2021-23, February 23, 2021, pp. 13-14

[9] Anikeev v. Commissioner, TC Memo 2021-23, February 23, 2021, p. 12

[10] Anikeev v. Commissioner, TC Memo 2021-23, February 23, 2021, pp. 17-18

[11] Anikeev v. Commissioner, TC Memo 2021-23, February 23, 2021, pp. 20-21

[12] Anikeev v. Commissioner, TC Memo 2021-23, February 23, 2021, pp. 21-22

[13] Anikeev v. Commissioner, TC Memo 2021-23, February 23, 2021, p. 22