Earned $ 300,000 in credit card rewards. The IRS said it was taxable income.


Konstantin Anikeev, an experimental physicist, put together everything he needed for research outside his field.

His materials included American Express cards, the government’s view that credit card rewards are not income, and his own willingness to spend time buying gift cards and money orders. He took out the concept of personal finance websites – exploit the difference between unlimited 5% rewards and lower fees on gift cards and money orders.

“If you have a theory, you can test it experimentally. Some are easier to test, ”Anikeev said. “Others require a Large Hadron Collider or something like that. But this one was a little more accessible. “

It worked (mostly).

Anikeev’s financial optimization plan in 2013 and 2014, including $ 6.4 million in credit card charges, led to an Internal Revenue Service audit and the finding that he and his wife had more than $ 310,000 in income that they should have. have been taxed.

Judge Robert Goeke’s decision last month largely confirmed the Internal Revenue Service’s long-standing practice, which says that credit card rewards are generally nontaxable refunds. In other words, buying a pair of shoes for $ 100 and getting a 5% reward is really a $ 95 purchase, not $ 5 of income. But the judge also offered the IRS avenues for stricter enforcement.

Anikeev’s interest in personal finance began when he was a graduate student with a lot of time but little money. The Connecticut resident relied on ideas from personal finance websites, he testified at his 2019 trial.

In 2009, he, like many others, used a rewards credit card to purchase $ 1 coins from the United States Mint, benefiting from the lack of shipping charges.

In 2013, he found the strategy that would lead him to a tax court.

His American Express card offered unlimited 5% rewards at supermarkets and pharmacies after spending $ 6,500. So, Mr. Anikeev used his AmEx card to buy prepaid Visa gift cards at grocery stores, routinely stopping during his trip and buying the maximum allowed per day at a store. She often used the gift cards to buy money orders, then she used the money orders to make deposits into her bank account, and then she used that money to pay her credit card bill.

On a $ 500 transaction, the 5% rewards would yield $ 25, more than enough to cover the gift card fees of about $ 5 and the $ 1 fee on the money order.

The millions of dollars from those transactions triggered sensors in the Treasury Department’s Financial Crimes Enforcement Network, which investigates money laundering, an IRS attorney said during the trial. That agency sent the case to the IRS, which said it owed back taxes. Anikeev took the government to court and brought a pot of gift cards to his trial to prove what he did.

“In a way they chose to fight the wrong person,” said his attorney, Jeffrey Sklarz. “They should have picked someone who was a mess.”

Judge Goeke issued a split judgment. The rewards obtained from the purchase of Visa gift cards are not taxable, he ruled, because the cards are products; Most, but not all, of Mr. Anikeev’s transactions were conducted that way. Rewards earned on money order purchases or debit card refills are taxable, the judge determined. The IRS already says that rewards may be taxable if earned without spending, such as a bonus for opening a bank account.

The two parties have yet to calculate what additional taxes Anikeev might owe. Andrew Johnson, a spokesman for American Express, declined to comment on the Anikeev case. He said the company uses a “combination of strategies” to enforce the rules of rewards programs that do not allow the purchase of cash equivalents. The IRS does not comment on active litigation.

Anikeev said he was somewhat disappointed. He said the judge’s distinctions ignore that the IRS classifies money order businesses as services and that money orders are items and therefore any rewards for purchasing them should not be taxable.

Judge Goeke came up with an alternative way for the IRS to attack future transactions like Mr. Anikeev’s.

Perhaps, he wrote, if gift cards are owned, the rewards reduce a person’s cost base at that property. Following that logic, exchanging gift cards for money orders would be to sell a property for a profit. The judge urged the IRS to consider regulations or public statements to offer clearer rules in case people are confused.

“How do you know when you cross the line?” said Robert Tobey, a partner at the Grassi accounting firm in New York.

SHARE YOUR THOUGHTS

What non-traditional methods have you used to invest and raise capital? Share your stories with us. Join the conversation below.

The case highlights a flaw in the IRS ‘approach to credit card rewards, said Stephanie Hoffer, professor of tax law at Indiana University McKinney School of Law.

Treating them as refunds makes sense for product purchases, he said. But in Anikeev’s case, there is no purchase of goods or services, just a circular flow of money.

“I was very surprised by the outcome of the case. To me, this clearly appears to be income, ”Ms. Hoffer said. “At the end of the day, does this taxpayer have access to wealth? The answer is clearly yes. “

Ordinary credit card rewards users need not fear that they are earning taxable income. Still, the case is a warning that activity far outside the norm could get the government’s attention, Tobey said.

Anikeev said he is not doing anything like what he did in 2013 and 2014, although he remains just as interested in personal finance.

“He is a brilliant and very mathematical person,” said his attorney, Mr. Sklarz. “And this was something that I thought was fun.”

Write to Richard Rubin at [email protected]

Copyright © 2020 Dow Jones & Company, Inc. All rights reserved. 87990cbe856818d5eddac44c7b1cdeb8

.

Source link