I’ve been a BankDirect checking account customer since July 2003 and I’ve earned hundreds of thousands of American Airlines miles from the account as a result. While some people have used the account to earn miles as an investment return in a low interest environment, I’ve just used it as a… checking account.
With significant reimbursed business expenses I tend to have large balances in my checking account, but this is short term cash that’s going to be used to pay off my credit cards. This isn’t money I’d realistically be investing. Earning miles versus paltry interest has been great. However it’s a strategy that’s only made sense with a decent account balance since BankDirect introduced a $12 per month fee that cannot be avoided.
One of the things that’s made BankDirect really attractive to customers is that they haven’t done tax reporting on the miles awarded. However there are a lot of misconceptions about thos.
- It’s often suggested that BankDirect wasn’t “taxing the miles” but that’s false – they just weren’t telling the IRS about what they were giving to customers as return on the checking accounts.
- Whether or not something is reported to the IRS doesn’t determine whether it’s taxable. If miles are taxable then you owe tax on the miles, whether BankDirect reports the payment of miles or not.
BankDirect is now taking the position – consistent with other banks that awarding miles as a return on your cash balances is tax-reportable. They’re going to send out 1099s for the first time at the beginning of 2021 for the miles they award in 2020. This has many customers concerned. All of a sudden the IRS will know about the return on these accounts and they’ll have to pay taxes on that return.
Remember, if something is taxable you owe tax whether it’s reported to the IRS. I don’t consider it a good strategy just to hope the IRS doesn’t learn about income you receive.
My concern wasn’t with the tax reporting but with the value of the miles that’s reported. Bear in mind that BankDirect really doesn’t determine how much the miles are worth – that’s something you can dispute. However often reported value is well above real value, which is why it can be too much of a hassle to win miles as a prize. If the contest sponsor reports a crazy value like 3.5 cents, and you don’t dispute the valuation, the tax burden could be greater than the miles you’ve won.
It looks like the value BankDirect reports will be less than the 1.4 cents apiece I think they’re worth.
According to this report they’ll report miles at 0.42 cents apiece in value. If you’re in the 32% tax bracket (single filer earning $160,726 to $204,100, married filing jointly earning $321,451 to $408,200) each mile each mile will effectively cost you 0.1344 cents apiece. That’s not 13 cents – that’s 13 tenths of a cent.
How can they report miles at a valuation this low? The value should be the market value, the price a willing buyer and seller would settle on. American often sells miles for around 1.8 cents apiece. BankDirect is paying less than that for sure. I imagine BankDirect’s lawyers are looking at the cost of their miles, and splitting out the various components of what they’re buying.
- Points to be awarded to customers
- American’s brand for advertising
- Marketing support, the ability to reach American Airlines customers via email
If BankDirect is paying, say, 1.2 cents per mile and breaking out the value of what they’re buying across these three categories then assigning one third to future travel seems reasonable. I’m not sure it’s right (since the cost of the miles to BankDirect doesn’t determine value to the consumer) but I like the approach that the bank is reportedly taking here.
Bear in mind that the first 1099 won’t be sent for over a year, so the valuation may change between now and then.
One Mile at a Time says that earning about a 1.2% rate of return after monthly fees and taxes isn’t great, but I disagree – it’s pretty great if you’re using BankDirect as a checking account, not great if you’re using it as an investment account.