I’ve been noticing that Amex has been running a lot of TV ads for the Plum Card recently and it got me to thinking: What is the true value of its 2% early pay discount? Aside from the time value of money aspect, are there tax implications for small business owners that reduce its usefulness even further?
The tax argument against business cash back cards
It’s commonly accepted that any cash rebate that you receive from personal credit cards is not taxable, as it just another form of a discount to you. In the case of a business, however, when the cash rebate is treated as a discount, it reduces the cost basis of your purchase. As a result, this decreases your effective rebate by your marginal tax rate.
To make this concrete, consider this example: You purchase merchandise for $100. You resell it for $150. Your credit card gives you 1% cash back. Your cost basis is actually $99 then. So your profit was $51 instead of $50, and you’ll be taxed on that extra dollar you earned as a rebate. If your effective tax rate of your business is 40%, after tax you made $30.60 ($51 x 0.6) instead of $30 ($50 x 0.6). Your effective credit card rebate then is 0.6% rather than 1%.
What about business miles cards?
Now then the question becomes: is it any better when you earn points or miles instead of cash back? The answer, I believe, comes from IRS Announcement 2002-18:
Most major airlines offer frequent flyer programs under which passengers
accumulate miles for each flight. Individuals may also earn frequent flyer miles
or other promotional benefits, for example, through rental cars or hotels. These
promotional benefits may generally be exchanged for upgraded seating, free
travel, discounted travel, travel-related services, or other services or benefits.
Questions have been raised concerning the taxability of frequent flyer miles or
other promotional items that are received as the result of business travel and
used for personal purposes. There are numerous technical and administrative
issues relating to these benefits on which no official guidance has been provided,
including issues relating to the timing and valuation of income inclusions and the
basis for identifying personal use benefits attributable to business (or official)
expenditures versus those attributable to personal expenditures. Because of
these unresolved issues, the IRS has not pursued a tax enforcement program
with respect to promotional benefits such as frequent flyer miles.
Consistent with prior practice, 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. Any future guidance on the taxability of
these benefits will be applied prospectively.
This relief does not apply to travel or other promotional benefits that are
converted to cash, to compensation that is paid in the form of travel or other
promotional benefits, or in other circumstances where these benefits are used for
tax avoidance purposes.
Essentially what the IRS is saying is that because it’s too much of a hassle to put a value on your points or miles, they won’t make an attempt to tax them. If, however, you convert them to a cash equivalent, you should pay tax on them.
So, on the one hand you have cash back rebates that are taxed; on the other you have mileage and point rewards that the IRS will not pursue–if all other things are equal, which card are you choosing?
Let me take the time to issue a disclaimer: I am not an accountant, and you should not take this as tax advice. Consult a professional before taking any action.