The IRS could not, in opposition to its long-standing policy of treating credit card rewards for the purchase of products or services as nontaxable purchase rebates, require taxpayers to include in income large amounts of credit card rewards they received for purchasing Visa gift cards.
Nadezhda and Konstantin Anikeev both held American Express Blue credit cards in 2013 and 2014. Under its Blue Cash Rewards Program, American Express would pay cardholders who made eligible purchases Blue Cash Reward Dollars. The number of Reward Dollars paid was based on a percentage (1% or 5%) of the dollar amount of the cardholder's eligible purchases, with no limit on the amount that could be awarded during a year. Eligible purchases included purchases of Visa gift cards, purchases of money orders, and purchases of reloadable debit cards and reloads of those cards.
The Anikeevs figured out a way to make the Rewards Program work for them without actually buying any goods or services. The couple would use their cards to purchase as many Visa gift cards as they could, paying service fees on the cards of 0.8% to 1.2% of the face values of the cards. They then used these gift cards to purchase money orders, for which they were charged service fees of 0.07% and 0.33% of the dollar amounts of the money orders, and deposited the money orders into their bank accounts.
At the end of each month, when they paid their American Express bills with the money they deposited (or sometimes by using reloadable debit cards or money orders purchased with their Blue cards), they were awarded the applicable percentage of their total purchases in Reward Dollars. The fees the Anikeevs were charged for their purchases of Visa cards, debit cards, and money orders were less than the total Reward Dollars they received, and the couple came out well ahead on these transactions, essentially receiving a cash payment from American Express through their aggressive use of the Rewards Program. However, at no time did American Express complain about the way the couple were gaming the program.
Pursuing their system on a grand scale, the Anikeevs used their Blue cards to make a large number of charges (mostly to purchase Visa gift cards, but also for money order purchases and debit card reloads) that earned them Reward Dollars. They redeemed $36,200 in 2013 and $277,275 in 2014 in Reward Dollars as statement credits. On their federal income tax returns for the years, they did not include any income from the Rewards Program. While American Express did not mind the couple's gaming its program, the IRS objected mightily to their omission of the amount of their redemptions of the Reward Dollars from their income. After auditing their 2013 and 2014 returns, the Service issued the Anikeevs a notice of deficiency increasing their income for 2013 by $29,775 and for 2014 by $265,485.
The Anikeevs challenged the IRS's determination in Tax Court. In Tax Court, the IRS increased the amount of income it claimed the couple omitted to $36,200 for 2013 and $277,275 for 2014.
The parties' arguments
The IRS took the position in Tax Court that the Reward Dollars the Anikeevs redeemed were ordinary income to them when issued by American Express, arguing that the gift cards were cash equivalents because of the Anikeevs' intended use of the cards to purchase money orders. The IRS initially argued in the alternative that the couple should report as income the gains on the couple's purchases of money orders with Visa gift cards, reducing their bases in the Visa gift cards by the Reward Dollars they received on the purchases of the Visa gift cards. However, it later abandoned this argument.
The Anikeevs maintained that under the rebate rule, as set forth in Rev. Rul. 76-96, a purchase incentive such as credit card rewards or points is not treated as income but as a reduction of the purchase price of what is purchased with the rewards or points. In their view, the gift cards they purchased were goods and services and their subsequent use was irrelevant.
The Tax Court's decision
The Tax Court held that the Anikeevs were not required to include the Reward Dollars related to the purchase of Visa gift cards in their income, but they were required to include the Reward Dollars related to direct purchases of money orders and cash infusions into reloadable debit cards in income.
IRS policy, set out in Rev. Rul. 76-96, treats payments made by a seller to induce a purchase of property not as income but instead as a purchase price adjustment to the basis of the property purchased. However, according to the IRS, the Anikeevs did not purchase property: They purchased cash equivalents in the form of Visa gift cards, and the Reward Dollars paid related to those purchases was an accession to wealth and income under Sec. 61.
The Tax Court explained that the IRS's long-standing policy in Rev. Rul. 76-96 reflects the recognition that a taxpayer who avails himself or herself of a discount in acquiring goods and services has no accession to wealth. The taxpayer has retained more of his or her wealth than a taxpayer who pays full price for the same good or service, but that taxpayer has gained no additional wealth and thus has no additional income. The taxpayer has simply consumed less of his or her existing wealth.
The Tax Court stated that the "case rests squarely in the legal chasm between the basic principle to broadly define income and [the IRS's] own policy. [The Anikeevs'] aggressive efforts to generate Reward Dollars have created a dilemma for [the IRS] which is largely the result of the vagueness of IRS credit card reward policy." To avoid violating its policy from Rev. Rul. 76-96, which would otherwise apply, the IRS sought to apply the judicial cash-equivalence doctrine, claiming that the Reward Dollars were not purchase price adjustments but rather were cash equivalents that were property equal to their face value. In the IRS's view, no price adjustment was possible for the gift cards because cash equivalents have basis equal to their face values.
The Tax Court noted that it had relied on the cash-equivalence doctrine to evaluate the proper timing of income recognition when a taxpayer receives a contractual right to receive payment in the future. The court found, though, that in those cases, it had applied the doctrine to certain types of debt obligations to solvent obligors and that the Reward Dollars were not such debt obligations. Thus, the application of the doctrine was not appropriate in the Anikeevs' case.
The court found that, instead, it must apply the law, including IRS policy not to include credit card rewards in income, and not expand established common law to accommodate the IRS's attempt to limit its own policy. Therefore, it was obliged to apply the terms of the IRS's credit card rewards policy as set out in Rev. Rul. 76-96.
Under the policy, credit card rewards for purchases of products or services are treated as nontaxable purchase price rebates. The IRS argued that the Visa gift cards, which made up the bulk of the Anikeevs' purchases that generated Reward Dollars, were not products. The Tax Court disagreed, noting the cards were not redeemable for cash or eligible for deposit into a bank account, which was why the Anikeevs used them to purchase money orders. The court further observed that the cards provided the benefit of using a gift card as a substitute for a credit card and that "providing a substitute for a credit card is a service via a product which is commonly sold via displays at drug stores and grocery stores." Moreover, American Express treated the purchase of the cards as eligible for Reward Dollars. Consequently, the purchases of the Visa gift cards were purchases of products or services, and, under the IRS policy, they were nontaxable purchase rebates.
However, the Tax Court determined that the direct purchases of money orders and reloads of cash into the debit cards using the American Express cards presented a different question. While the Visa gift cards had product characteristics, the court found that no product or service was obtained, other than cash transfers, by using the American Express cards to purchase money orders or put cash into the reloadable debit cards. The court concluded that the money orders were not properly treated as a product subject to a price adjustment because they were eligible for deposit into the Anikeevs' bank account from acquisition, and, similarly, the cash infusions to the reloadable debit cards were not product purchases. Thus, the court upheld the inclusion in income of the Reward Dollars related to the direct purchases of money orders and the cash infusions to the reloadable debit cards.
As the Tax Court made clear in its opinion, it was perfectly receptive to the IRS's alternative argument that the Anikeevs were required to recognize gain on their purchases of money orders with the Visa gift cards (the bases of which would be reduced by the Reward Dollars received for the cards' purchase). Taking a dim view of the IRS's attempt in this case to rein in what was arguably an abuse of its policy of excluding from income credit card rewards for product or service purchases, the court stated, "We hope that [the IRS] polices the IRS policy in the future in regulations or public pronouncements rather than relying on piecemeal litigation."
Anikeev, T.C. Memo. 2021-23