It used to be all frequent fliers had to fret about was whether they could snare a free first-class upgrade to Cleveland or earn enough miles for that dream vacation in Waikiki. But in the wake of a well-publicized tax audit last year, Uncle Sam has added a new worry: stronger enforcement of a rule requiring income taxes on frequent-flier awards.
Although most airlines insist that their frequent-flier awards are a form of consumer rebate--and thus tax-free--the Internal Revenue Service takes a different view. U.S. tax troops consider personal trips to be fully taxable when the travel that earned the mileage was paid for by an employer. "If you receive miles for business travel and you use them for personal travel, you've created a taxable event," says IRS spokesman Don Roberts. "So you should report the fair-market value of that [award] ticket as income."
If this comes as news to you, you're not alone. Almost none of the 30 million flier-plan participants pay taxes on their freebies. A major reason: lax IRS enforcement. No IRS taxpayer bulletins explain the tax treatment of flier benefits or even how to value an award--a tough call given today's myriad fares. And in a private decision last year, the IRS ruled that airlines don't have to give the feds periodic listings of flier account transactions or file Form 1099s, which alert the IRS to miscellaneous income, for members redeeming awards. "This is really an area that hasn't been policed," explains Tom Jackson, senior tax partner at Deloitte & Touche.
That means an IRS agent has to catch you, probably during an audit. Last year, several employees of a Florida software company were assessed back taxes and interest after an audit discovered the employer was buying the flier mileage from them for cash. While such sales are against airline rules, they aren't illegal. But the auditors found the employees never reported the cash payments as income on their tax filings.
So far, the handful of IRS cases related to frequent-flier awards has involved cash paid for mileage or upgrade benefits. "That doesn't mean the IRS won't pursue the other side of the coin: noncash transactions or free travel that's harder to value," warns Stan Dale, publisher of Mileage & Points. He figures fliers most at risk for scrutiny are those who report extensive business travel on Form 2106 or Schedule C.
Tax experts still believe people who earn an occasional freebie as a result of company trips have little chance of being nabbed if they don't report the awards. But those who accept cash payments for mileage or file forms
that flag heavy business travel might find a subsequent visit from the feds especially taxing.