IRS notified that the air miles represent miscellaneous income....

[Dexter Dogg]

Frequent-flier miles are taxable? Really?

That sentiment sums up the reaction from readers — and particularly accountants and lawmakers — to last week's column on Citibank sending tax forms to customers who received thousands of airline miles in return for opening a new account.

Citi is notifying the Internal Revenue Service that the miles represent miscellaneous income, leaving customers on the hook for paying related taxes or possibly facing a greater risk of being audited.

What does the IRS have to say about the matter? After days of my pestering the tax agency for a response, it finally took a stand on the taxability of miles. I'll get to that in a moment.

First, it's worth noting how confusing the issue is even for those with a deep knowledge of tax law. Financial experts weren't sure what to make of Citi's claim that frequent-flier miles are a prize or award and thus represent taxable income.

Sen. Sherrod Brown (D-Ohio), chairman of the Senate Banking Subcommittee on Financial Institutions and Consumer Protection, was so flummoxed that he wrote a letter to Citi's chief exec, Vikram Pandit, calling on him to stop sending miles-related tax forms to customers.

"The last thing Citibank should be doing is creating baseless fear in middle-class families, or placing a nonexistent tax burden on the backs of families who are already struggling to make ends meet," Brown wrote.

Tax professionals told me Citi's actions raised a lot of questions. If miles are taxable because they're a prize or award, does that mean any corporate freebie, no matter how small, must also be declared?

Since virtually all frequent-flier miles are awarded as an incentive by businesses, does that mean all miles are taxable?

And how should miles be valued for tax purposes — as whatever a company says they're worth, or, as in Citi's case, the almost certainly lower amount the bank paid to originally purchase the miles from American Airlines?

"These are issues I'm going to have to discuss with all my clients," said Michael Eisenberg, a Los Angeles CPA. "This is suddenly a big deal, and the IRS needs to make a definitive ruling on it."

Citi, for its part, added to the confusion by insisting that even though miles given to customers for opening a new account are taxable, miles awarded for using a credit card are not.

"Rewards and airline miles that are provided in connection with a purchase on a credit card are routinely not subject to individual income tax reporting," said Sean Kevelighan, a Citi spokesman. "When a customer receives a gift for opening a bank account — whether cash, a toaster or airline miles — the value of that gift is generally treated as income and subject to reporting.

"This is separate and distinct from miles or points earned by our credit card customers for their purchases."

Rob Seltzer, a Century City CPA, said he couldn't understand that distinction.

"It's completely inconsistent," he said. "How are miles for opening an account considered a prize or award, but miles for using a credit card aren't considered a prize or award? What's the difference?"

That's the big question. And the IRS has stepped up with an answer.

"When frequent-flier miles are provided as a premium for opening a financial account, it can be a taxable situation subject to reporting under current law," said Michelle Eldridge, an IRS spokeswoman.

OK, so Citi apparently has that part right. But what about miles received for using a credit card or handed out by an airline just for taking a trip?

[HarveysMum]

crap! I hope they dont do that in the UK!

[Sophiesmama]

This is the craziest thing I have ever heard!

[BauersMom]

That doesn't even make sense, how can they determine how much a mile is worth?

[Labs4life]

Crap. The only "perk" for spending 150 nights a year away from my family and friends, going without the wonderful pleasure of kicking off my shoes in my own house, is a few free airline tickets. I usually give away the airline tickets to my daughters so they can go somewhere and save a few dollars.

Citibank and their warped way of thinking pisses me off more and more. I'm really re thinking that this too big to fail plan was not such a good idea.

[BigBrownDog]

I think you also ought to earn a commensurate deduction for every single minute spent sitting in coach then.

[BauersMom]

I think you also ought to earn a commensurate deduction for every single minute spent sitting in coach then.

I am totally on board with this idea!

When I used to travel a lot, I almost always got bumped to first class. Now that I don't travel as much, and have to fly coach . . . it sucks! Jerry Seinfeld was right. I rarely sat near a "screaming lap child" in first class.

[Maple1]

Difficult issue, but can see a case being made - the bank purchased the miles from the airline for $x and awarded them to customers, basically buying the customer [paying the customer to use Citibank]. Bank deducts cost as business expense, customer has taxable income.

[BauersMom]

Difficult issue, but can see a case being made - the bank purchased the miles from the airline for $x and awarded them to customers, basically buying the customer [paying the customer to use Citibank]. Bank deducts cost as business expense, customer has taxable income.

How much? How is there anyway to determine the value of the miles received? Miles used to fly from LaGuardia to Heathrow are going to be worth less than miles to fly from Flint to Heathrow. Until they're used, how can it be determined what they're worth?

[Dexter Dogg]

I'll be interested to see how this plays out.