Many of us accumulate airline miles when we fly with certain airlines or use certain credit cards. And, many of us choose to spend these “earned” miles on other flights, upgrades, hotel rooms, and a variety of other goodies.  As use of airline miles began to become more prevalent, some frequent fliers began to wonder if there was something “taxable” about either the receipt or use of these miles. In 2002, the IRS officially answered the question: The IRS will not assert that any taxpayer has understated his federal tax liability by reason of the receipt or personal use of frequent flyer miles or other in-kind promotional benefits attributable to the taxpayer’s business or official travel. In other words, miles aren’t taxable. All rejoiced at this news—miles from a February business trip to Nebraska could be put toward an April vacation to Italy. Now, I bet you’re wondering about the toasters aren’t you….

In January 2012, Citibank surprised a number of its customers with taxable income from an award of airline miles.  During 2011, Citi offered new customers (people that opened either a savings or checking account) 25,000 to 30,000 American Airlines miles and valued them at 2-1/2 cents each, or about $625 for 25,000 miles.

Still wondering about the toasters, right?

Apparently, Citi reasoned that the receipt of miles is like a prize for opening a new account.  Per the IRS’ guidance in 2000, bank customers have additional interest income if they get a promotion item like a toaster from a bank that “does not have a value in excess of $10 for a deposit of less than $5,000 or $20 for a deposit of $5,000 or more.” Citi, recognizing that the miles were something of value given to customers when they opened new accounts, reported them as a prize. Since the IRS rule states that prizes must be valued at their fair market value, Citi ballparked their value at 2-1/2 cents per mile.  I checked two airlines, Alaska and Hawaiian, and they each charge about 2-3/4 cents to customers who wish to purchase additional airline miles. Online sites that offer to purchase your miles pay about 1 cent per mile. As such, Citi’s 2-1/2 cents is on the high side but not totally out of line.

Does this mean that we all have income when we get airline miles from credit card purchases or use them to buy stuff? Nope, the IRS unofficially says (as of January 31, 2012) that using and getting miles is like getting a rebate or using a coupon; they reduce the price of the items we purchase… but only if we use them. That said, it looks like you won’t get toasted if you earn or use miles after all.