Credit card rewards seem like free money. But to the Internal Revenue Service, they are either a rebate or an award, and the distinction determines whether they are taxable.
If you get the credit card rewards only after some kind of financial transaction, such as a purchase, the rewards are considered rebates and are not taxable. The IRS thinks of the rewards as a discount on the purchase rather than some kind of gain in income or wealth. These "rebates" include cash back, miles or points toward merchandise.
Many credit card sign-up bonuses are exempt, as well, because they often require some kind of financial action on your part to get the reward. Some sign-up incentives require that you charge a certain amount of money to your card within a specific time frame before getting the reward. Others are easier and give out the reward after the first purchase. But in both instances, a financial transaction was required of you before the reward was given, so it's a discount rather than an award in the IRS' eyes.
However, if no transaction is needed to get the reward, except for signing up, then the IRS considers these rewards an award that does add to your income or wealth. Last year, some customers who received a cash reward just for opening a checking or savings account with the bank found a 1099-MISC tax form in the mail. The form documents miscellaneous taxable income received during the tax year.
Other companies state they will report rewards currency as income to the Internal Revenue Service, state, and local tax authorities if required by applicable law.
In that case, it appears the bank will only report those rewards that are considered awards, rather than discounts or rebates (as explained above), under tax law.
Also, check the terms and conditions. There could be other tax implications when it comes to credit card rewards. For instance, if cardholders have donated their rewards to a charity -- another option card issuers offer -- they should be sure to ask a tax adviser if that donation is considered tax-deductible.
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To ask a question of the Credit Card Adviser, go to the "Ask the Experts" page and select "Credit Cards." Read more columns by the Credit Card Adviser. Follow Janna Herron on Twitter.