Free but taxable? Frequent-flier miles raise questions at IRS

April 12, 2012

It’s a frequently recurring headache for the IRS: Determining whether the value of frequent-flier miles employees accumulate when they travel on business is a tax-free fringe benefit or taxable compensation.

The IRS thought it had settled the issue in 2002, when it announced that it wouldn’t waste its time trying to figure out how to tax them. The issue of whether frequent-flier miles are taxable arose anew after a bank sent Forms 1099-MISC to customers who received miles as part of a promotion for opening accounts.

So much more than a toaster. According to the bank, the frequent-flier miles were taxable to its customers because they received their miles as a reward for opening accounts. The 1099-MISC forms, therefore, were appropriate. For its part, the IRS has agreed with this analysis, and noted that its 2002 announcement was focused on employees who receive frequent-flier miles while they’re on business trips paid for by their employers.

Frequent-flier primer

This dust-up is a good reminder that the IRS’ 2002 announcement wasn’t open-ended. It’s clear that it doesn’t apply to miles or other promotional benefits that employees convert into cash, to compensation that’s paid in the form of miles or other promotional benefits or in circumstances where miles or other promotional benefits are used for tax avoidance purposes.

To keep employees’ frequent-flier miles personal and tax-free:

  • Don’t give frequent-flier miles to employees as awards or prizes.
  • Don’t set up special corporate deals with airlines that allow employees to accumulate miles faster than the general public.
  • Do allow employees to communicate directly with airlines to establish their own accounts.
  • Don’t require employees to turn their miles into the company for a cash payment.