US Tax Court Weighs In On Whether Manufactured Spending Is Taxable Income; Theories For Why The IRS Chose Their Losing Argument

105
DDMS IconNever Miss Another Deal - Follow DansDeals on Facebook

There is a fascinating tax court case that was filed yesterday, ANIKEEV v. COMMISSIONER OF INTERNAL REVENUE.

Bloomberg says the case was a big win for the IRS.

However, Green & Sklarz LLC says they won big for their client who was fighting the IRS.

So…who’s actually right?

I’m not a lawyer, but let’s try to dissect what happened.

In general, rewards on credits card signup bonuses and spending are not considered taxable income. That’s true whether the rewards are for miles or cash back as they’re considered a rebate of the purchase price of the products or services bought. On the other hand, rewards earned from banking activities, referrals, and other activities that aren’t based on buying goods or services are considered taxable income.

In this case, the IRS accused husband and wife, Konstantin Anikeev and Nadezhda Anikeev, of failing to declare income earned from manufactured spending. That’s when you use your credit card to purchase items that can be liquidated into cash in order to earn rewards.

The couple didn’t play small ball. In 2013 and 2014 they deposited $4,028,743 in money orders into their bank accounts!

As I always say, pigs get fat, hogs get slaughtered. That level of cash deposits into your bank account are bound to raise a red flag. I’d assume that enough suspicious activity reports were filed by their bank until the IRS took notice, but it’s unclear how exactly the IRS was tipped off.

They used a grandfathered Blue Cash AMEX that earned 5% at supermarkets and drugstores after spending $6,500 annually. They used that to buy Visa gift cards, debit cards, and money orders with their cards.

AMEX shut down their cards in 2014, but still paid out some 6 figures in statement credits. In 2017, the IRS wanted them to recognize additional income totaling $35,665 for 2013 and $276,381 for 2014 for their rewards points.

To generate the rewards, the Anikeevs bought Visa gift cards that they liquidated via money orders, they paid their bills via MoneyGram, they purchased reloadable debit cards, they reloaded debit cards, and they bought money orders directly with their AMEX cards.

The IRS said the items they bought were cash equivalents, and not goods or services. As such, the rewards were not a purchase rebate, but taxable income.

The Anikeevs argued that rewards on the purchase of gift cards should be considered a purchase rebate and not subject to income tax, regardless of what they are subsequently used for.

The court noted that the IRS policy for credit card rewards is vague and that had the Anikeevs not been so aggressive in their manufactured spending, the IRS would not have taken notice. As such, the court calls this an “extreme test of the longstanding nontaxability of credit card reward programs.”

The court found that most of the spending was on Visa gift cards, which were in turn liquidated. In the end, the court ruled that these gift cards are products, offer a service in the form of a plastic card, and are not directly able to be liquidated for cash. As such, earning rewards on these goods is not taxable income, even if a money order is subsequently purchased with them. Similarly, a reloadable debit card is a service and earnings rewards on it would not be considered taxable income

On the other hand, the court found that the direct purchase of money orders with a credit card, and the actual reloading of a reloadable debit card directly from a credit card are not product or service purchases. Therefore the rewards earned on direct purchases of money orders and cash infusions to the reloadable debit card would be subject to taxable income. Those types of transactions are much harder to do these days, so the ruling that rewards from purchasing and liquidating gift and debit cards is not considered taxable income is far more consequential.

That’s all based on the IRS policy to exclude rewards for product and service purchases from taxable income. Whether this case will cause a change to that official policy will be something that we’ll have to watch closely.

In short, as most of the spending was done to buy gift cards, this does appear to be a big win for the Anikeevs and for Green & Sklarz LLC, and they won’t have to pay income tax on most of the rewards! That means hundreds of thousands of dollars will remain in the Anikeev’s pocket.

And I’m not quite sure how Bloomberg got the case so wrong.

But let’s dig a bit deeper into the stranger part of the case that I’ve ignored up until this point. Why did the IRS make the flimsy argument that the rewards should be taxable instead of the obvious argument that the Anikeevs ultimately profited and made taxable income by cashing out the gift card for a money order? It would have been easy for the IRS to win the case with that argument. The IRS would have collected the same amount of unpaid taxes by calculating the amount in which the rebates exceeded the fees to cash out the gift card.

To learn more, I reached out to Green & Sklarz LLC for comment. This was Jeffrey Sklarz’s case, but he was unable to discuss the decision tonight, other than to say he was very pleased with the outcome.

I was able to speak with his partner Eric Green about the case. Mr. Green shared that when he first learned about the case, he told Mr. Anikeev point blank that he would lose. The IRS argument that there was income here would be an open and shut case.

But he was very surprised to see the IRS argue that the AMEX rebate should be considered taxable income due to buying cash equivalents, rather than their much easier argument about making a profit.

His theory as to why the IRS went down the much harder route was that they didn’t want people who are getting involved in rewards points to claim hobby losses when buying gift cards, as they might have if the IRS went after the added income argument.

I offered a theory based on my own usage. I buy Visa gift cards from Staples using my Chase Ink Cash card to earn 5 miles per dollar spent. If the IRS was able to get a broad ruling about rebates from the purchase of gift cards being taxable as they are not goods or services, they could potentially come after people like me even if I only transferred the points into United miles. While miles earned from credit card purchases aren’t taxable, miles earned from checking accounts are taxable and the bank comes up with an estimated value.

With a broad ruling in their favor, the IRS could demand that the value of the miles earned from the gift card purchases be included in taxable income, even if I later gave the gift card to someone as a present or donated it to charity, rather than cashed it out via a money order.

Luckily for us, the court refused to recognize that overly broad and flimsy IRS argument. In trying to create a potential precedent, they swung and missed. They can appeal the court’s decision, but they can’t change arguments against Mr. Anikeev for the easy win. Still, a higher court may disagree with the distinction between buying gift cards and buying money orders.

Let’s hear your theories about this case in the comments below!

HT: R.A.T., via DDF

Leave a Reply

105 Comments On "US Tax Court Weighs In On Whether Manufactured Spending Is Taxable Income; Theories For Why The IRS Chose Their Losing Argument"

All opinions expressed below are user generated and the opinions aren’t provided, reviewed or endorsed by any advertiser or DansDeals.

Baltimore boy

Seems like a big win for the Anikeevs, given the liquidity of gift cards. (Confused about the date of the post. The decision, T.C. Memo. 2021-23, just came out yesterday (2/23/21), but the post is dated 2/24/19 rather than 2/24/21.)

KSMH

Ruling makes sense in my mind (based on reading the article), a MO is somewhat considered a cash equivalent..

Sam

This got me in the mood of vanilla ice cream

Shmilfke

Just goes to show just because a lawyer says “you will lose”, doesn’t mean you should stop pursuing it. In every case, there’s at least one lawyer who thought the eventual winner would lose

S209

This isn’t true at all.

Slow Joe

I don’t see why your other argument is better. They didn’t earn a profit when cashing out the gift cards because they spent money to buy those GC’s. For example if they bought a $500 visa gift card and then cashed it out minus the fees they didn’t earn any profit in fact they lost money.

Shmilfke

Does this mean Dan has probably never paid income taxes?
Maybe this is also what Trump was doing all along

Shmilfke

It’s always nice when someone beats the taxman

TC

Thanks Dan!
While I would love to put on my 2 cents, I don’t have any, as you explained all details very well and your theory sounds right to me.
Thanks for another awesome post!

Yosef

Good thing, otherwise Dan might need to pay tax on the two cents!

Anon

“And I’m not quite sure how Bloomberg got the case so wrong.”
I wonder who the author is.

Hjay

Most websites I saw this posted on were reporting it as “earning points are taxable”

Elokut

Can you please sum up in short.. i’m a shtikle confused

Baltimore boy

A while back, the IRS issued a field service advice concluding that frequent flyer miles were gross income. They then backtracked from that position, possibly due to public/industry pressure. However, GCs are arguably different given their liquidity (and fungibility). So arguably the CC holder has recognized income when it “purchases” the GC. Also, think about it- nobody’s getting GCs to hold onto them long-term; they’re held to use ASAP. So it’s not a stretch to argue that receipt of the GC that will be liquidated shortly is income.

From a tracking perspective, the IRS may get information from CC companies regarding GC purchases. They’re much less likely to get information telling it when the GC has been utilized.

I don’t buy Mr. Green’s theory about the IRS being concerned about people claiming losses from GCs. 1st of all, where’s the loss? 2nd, such losses would generally be personal and therefore non-deductible. 3rd, even if they were hobby losses, they’d only be deductible to the extent of hobby income. (Maybe for Dan it would be a business loss, but Dan probably wouldn’t have losses in the 1st place!) 🙂

Tov

I guess stimulus going on, somewhere they have to fill it in

rafi

i don’t get “his theory” why would they be a loss when buying gc? the rewards offset the fee in most cases

Alex

From the original documents I read, my understanding was that IRS won.
They had a very high churn rate on AMEX card, $4MIL in 9 months with only $15K spend limit. So I wonder why AMEX did not notice and shut it down. The bank must of triggered the alarm with $4MIL in MOs, as it looks like money laundering. They tested the system to the extremes, just like the judge noticed, and for that they deserve the rewards earned.

Aaron

Great write-up Dan! One problem with your theory, the IRS is allowed to propose alternative arguments, so they would have nothing to lose by arguing the basis reduction/profit theory as well.

EliJelly

Once a GC is deemed a product and not a cash equivalent then no argument can be made whether liquidating them ultimately left them with a profit or not. How about one who uses his 5% earning cash back CC to buy furniture for instance, and then intentionally sells them at a loss of 3%, would the 2% “profit” he earned be taxable? No.
So the IRS wanted GC to be considered cash equivalents and the court ruled it has a “Din” product, and effectively just like a piece of furniture.

calwatch

A GC is absolutely not the same as a cash equivalent. Tax Court is right on this one. It can only be used for the purchase of goods and services that accept whatever brand of card in the US. A Redbird/Bluebird has ATM access and a universal bill pay feature, including to the owner of the card, and a money order can be cashed out or deposited at a bank. Those are properly cash equivalents.

yitz

Dan you might not be a schooled lawyer. You do a good legal analysis

Malibumiler

Great post Dan, thanks for sharing the case info. This is a Big Win for MS! Oh… 2014… bluebird / vanilla reload combo days

azhoopsfan

Back in the day, checking account bonuses were not taxable either until Citi started issuing 1099s. What happens when one credit card company (likely Citi) starts issuing 1099s (at least for sign up bonus points)? Will the other credit card companies follow suit?

yankel

they already do for referral bonuses

zeesh

Thanks. I’m still waiting for a piece on Maaser Kesafim on points.

calwatch

I’ve requested a copy of the stipulated facts, all 1581 pages: https://dawson.ustaxcourt.gov/case-detail/13080-17 Should be interesting reading!

S

Great post.
Even if they had to pay tax, I see it as a win being they made (well into the) 6 digits 🙂

Side question – why can’t the IRS open a new case going after the easy profit, like you mentioned?

Maybe

It is possible that if the IRS did not want to go after the profit/loss argument because then they would need to calculate each transaction from beginning to end instead of just being able to look at the amount of the reward at the time of purchase which would give them a precedent to collect taxes on most spending.

Yoel1

Dan, the only thing I can add,
IRS, you too should remember, pigs get fat, hogs get slaughtered.

anonymous

“The IRS would have collected the same amount of unpaid taxes by calculating the amount in which the rebates exceeded the fees to cash out the gift card.”
Is that so? From your example in comment: on a $500 GC, earned $25.30 in rewards, IRS wanted $25.30 in taxable reporting VS. only on profit, $18.30 in taxable income?

Sam

If the profits are income then its a busniess with 2 employees and many expenses vs just having points be blanketed as income period.

ChapsTheMatzav

Wow! So you buy visa gift cards from a supermarket and then you buy money orders with the gift cards?

ChapsTheMatzav

Dan, how long did it take you to write this?

Saul

This case can have implications for manufactured spend done via buying groups even if a higher court subsequently finds Visa gift card purchases to indeed be considered a purchase of a cash equivalent. When someone resells products to a buying group for cost price (as is often the case these days) and only profits from the miles, rewards points or cash back earned through the purchase of the products, he should not have any tax liability from any gain he receives via those rewards notwithstanding the fact that he has essentially resold those products for gain. This is all assuming the IRS doesn’t make any policy changes, as Dan noted. (This isn’t to say there aren’t other risks and issues associated with buying groups, but regarding tax liabilities, this can be a big benefit to those who do it).

DC

If I receive 5% cashback from sending an iPad to a buying group, why would that not be taxable? It has reduced the cost basis of the item I sold to them. I’ve made a profit. Clearly taxable.

Saul

You are 100% correct in theory, and that was what I’d assumed until now as well, but the point I made here was that as noted in the summary of this case, the IRS specifically declined to make this argument when it clashes with their longstanding policy on credit card rewards. They are in effect saying that credit card rewards, which they consider to be a purchase rebate, will never be taxed even when used for gain (such as MS), as long as it is indeed a purchase rebate for actual goods or services. The only argument they tried to make was that Visa gift cards are in fact a cash equivalent as opposed to actual product, an argument which they ultimately lost. When it comes to an iPad however, there will never even be any doubt, as no one will ever say that an iPad is a cash equivalent. This means that even if a higher court eventually does overturn this ruling regarding gift cards, the precedent should still stand regarding buying groups. In short, it’s the IRS themselves who defined their own longstanding policy this way. As noted in this post, they could’ve easily made this argument but did not for whichever reason, but the legal implication should be that as long as this policy stands and isn’t changed, it would apply even to credit card rewards which are earned for gain. It is really interesting and doesn’t seem to fully make sense, and that is precisely what is being discussed here.

Saul

If anyone with a legal background feels differently, feel free to comment, as I’m not a lawyer and can be wrong. However, it is clear that the IRS ignored any cost basis income argument in this case.

Jack out of the Box

I know a frum fellow who sells airline tickets off his points and reports the operation as a business on his tax returns.

Saul

No one will stop anyone from reporting it as income, but from the way the IRS argued this case, it seems to be unclear whether they consider ANY cc rewards income, even when exchanged for money.

Chaim

When I need to return things at Costco and Trader Joe’s, the refund goes on my debit card, and I keep the original credit card points on those purchases.

Is this an issue?

Saul

No one will care bother you if this happens once in a while and you profit a few dollars worth of rewards a year. If this would be done deliberately with hundreds of thousands of dollars, there are bigger problems than tax liability, as you would be deliberately making money off the store’s loss of the original credit card fees. They obviously don’t mind if this happens with an occasional customer return however, as they are willing to take an occasional insignificant loss for the sake of customer satisfaction.

DansFan

So what about the Chase feature of paying yourself back on grocery purchases? It seems like it’s still not taxable but could that change?

By the way – if the IRS would change their policy, would that be retroactive for that year? Previous years? Or only going forward?

james

maybe the appellate judge will be a points zamler

HelpMe

The ones that were slaughtered here was the IRS. If you are a pig you are starving.

Mendel

תפסת מרובה לא תפסת…

Steve

$4.0mm is a lot of תפסת

Shulem

Hi, let me understand, let’s say I’m a retail business, buying products on wholesale for 500$ and selling them on the retail market for 800$, how about I should just ask my wholesaler to sell it for me for 900$ and then give me points for a 400 rebate, can I file the end of the year with a loss of 100$ per piece???!!

Shulem

Great idea??…

zav

amazing! @ dan will it work??

wpDiscuz