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.
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Interesting take on this debatable change in procedure on the part of BankDirect. I guess what still leaves me uneasy about this (I have no skin in the game since I don’t have a BankDirect account) are your words, “Bear in mind that the first 1099 won’t be sent for over a year, so the valuation may change between now and then.” If it stays at 0.42 cents, your argument holds together (somewhat), although there are plenty of places to get a return on non-investment accounts of more than 1.2%. On a related topic hinted at by Lucky, what do you know about Bask Bank?
Jim – Bask is offering a bonus for their CD, so in the first year the miles will be cheaper than sticking with a BankDirect miles earning account.
The effective cost would be 13 *hundredths* of a cent, Gary, not 13 tenths (which would be 1.3 cents).
@ Gary — This may work for you, but I am probably out on the checking, as this change only makes the checking less valuable. I might open a savings account and give it a whirl with no monthly fee, full milage earning up to $250k, and a 5,000 mile signup bonus. It really depends what else is avaiable over the next few weeks since this is the month where I finally pay myself most of my pay for the year. I need to put the cash somewhere, and I think I’ll pass on the absurdly over-priced equities market for a while. The Trump train must crash at some point…
Just report the income that BankDirect reports and then make a negative other income line item for the amount you think BankDirect is over valuing the miles by as a valuation adjustment. If I can’t sell these miles because that is a restriction of the terms of the loyalty program, it is reasonable to assume a fair market value of zero, since there are no comparable trades that are allowed to occur. At the time you are valuing them, you may have no plans to ever use the miles and may anticipate the lack of ability to sell them means they have zero value. You can slug it out if you get audited, but it is a reasonable position to take.
@Rob – I think that position is a stretch. The issue isn’t whether you will get value out of the miles, it’s whether they have value, and indeed there is a market price where there are willing buyers, American Airlines sells miles to the public every day.
Gary – what value have you been assigning to the miles from BD for IRS purposes on your tax return in years past?
“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.”
@Gary. It’s generally accepted accounting to impair valuations of financial assets due to marketability, selling or voting right restrictions. When it comes to valuation for income tax purposes, I think it will depend on the value to you, not the value to American. They have value to American because they can sell them, but we can’t. We also can’t bequeath them upon our death, nor are we under any obligation to ever use the miles that are granted.
Now, if you are able to convert the points to cash somehow, even if it is against the terms and conditions of the program, then it becomes taxable income to you when you receive the cash and I would report that cash as income.
What puzzles me is that if the bank’s lawyers have determined that mileage awarded as interest is reportable, why won’t they send a 1099 for 2019? I’m not complaining; it’s good for us account holders. But from their side, it seems legally problematic to say miles are taxable, but we’ll wait a year to get compliant.
@swag That’s because it is not clear in the law. They are taking a position on unclear guidance. Previously they took a less conservative position. The reason for the change is anyone’s guess, but likely due to a new person being in charge of the decision who is perhaps more conservative on the issue. There seems to be general agreement among financial institutions due to a 2002 paper that the IRS won’t go after taxing points that the customer had to do something to get…like pay for a flight or spend money on a credit card. They seem to be fine with looking at those points as a form of rebate or discount. But the points granted as a sort of promotion where the person didn’t have to spend money to get have always fallen in this grey zone. i.e. Amex referral bonuses, bank account mile grants.
A two second pass by the Bankdirect Web site yields the following:
“BankDirect is no longer offering the Mileage Checking with Interest product. If you are interested in a mileage-based savings account, please visit Bask Bank. ”
Would have been a useful bit of info for this article. The blush really is off the miles and points rose at this stage of the game.
I’m puzzled by this. I thought that there was an IRS ruling from several years ago that frequent flyer miles are not taxable, because they are a discount rather than income. Is Bank Direct saying that when paid in lieu of interest, they are, in effect, interest income?