Banking rewards, incentives, and bonuses are often touted as one of the best ways to get “something for nothing.” For example, a bank may offer you $300 to open a new checking account and set up direct deposit. Or, you could earn bonus airline points worth more than $1,000 by opening a new travel rewards credit card and spending a certain amount on the card within a designated time frame.
The good news about most of these offers is that the requirements to earn the bonuses are simple to understand and easy to attain. Many bank offers require you to keep a certain amount of cash on deposit for a specific length of time, say six months, in order to earn the bonus. Rewards credit cards, on the other hand, typically dole out points based on whether you can spend a few thousand dollars within a specific time frame. (See also: Credit Cards with the Best Sign-Up Bonuses for Travel)
If you’re organized and have the money to spend, you’re golden.
One little detail that’s often not discussed, however, is whether you’re responsible for paying taxes on the value of the rewards. Different programs have different requirements, and it’s helpful to know what your responsibility might be.
Which rewards are taxable?
First things first. If you sign up for a bank account and don’t have to spend anything to earn the bonus, you’ll have to count your bonus as taxable income. This is because, unlike credit card rewards that require you to spend money upfront, bank bonuses are earned passively.
Let’s say you sign up to receive a new checking account bonus from a bank that states you’ll earn $200 when you open a checking account and set up direct deposit to the account. Since you didn’t have to buy anything, this bonus is considered income.
“Bank bonuses do not require a transaction,” notes Brian Ashcraft, Director of Compliance at Liberty Tax Service in Virginia Beach, Virginia. “Therefore, the IRS treats the bonus as an award that adds to your income.”
This may be a small hiccup in your plans to earn free money, but it’s not that big of a deal to pay taxes on bank bonuses. You won’t have to pay taxes on your bonus right away, after all. Ashcraft says you can expect to receive a Form 1099-MISC in the mail from the bank that offers your bonus as long as your bonus is higher than $600. Your bank is not required to send a 1099 for amounts less than $600, but you still need to claim the income as “other income” on line 21 on Form 1040 when you file your taxes.
Some rewards aren’t taxable
Beyond bank bonuses, many people love to pursue credit card and travel rewards. With the right cash-back card or travel credit card, you can earn points redeemable for cash back, gift cards, travel, or merchandise. Further, if you pay your credit card bill off right away and avoid paying interest, these rewards can truly be “free.”
Because you have to spend money on the card to receive the sign-up bonus or any rewards thereafter, credit card rewards are typically considered a rebate. This means they are not taxable, says Josh Zimmelman, tax consultant at Westwood Tax & Consulting in New York.
“Rebates are received after a financial transaction and are not taxable,” he says. “Sign up bonuses are considered rebates if they required a financial action to earn them.”
This means that, if you play your cards right, you could be earning hundreds or thousands of dollars in travel rewards or cash back without counting it as income on your taxes. The key is making sure your rewards are considered by the IRS to be a rebate instead of a bonus.
Covering the gray area
While it’s fairly easy to understand that bank bonuses are typically taxed and credit card rewards offered as a rebate aren’t, there is some gray area to be aware of, says Zimmelman.
Let’s say you received a bonus just for signing up for a new credit card but didn’t actually have to make a purchase to earn it. Zimmelman says that, in this case, your rewards would be taxable since a financial transaction wasn’t required to earn the bonus.
“Similarly, if you earned a reward for filling out a survey or providing information in some other way, that is also considered taxable income,” he says.
According to Turbo Tax, this side income is considered “miscellaneous income” and should be taken seriously, almost as if you’d earned it through a side job. Turbo Tax says you can prevent tax time snafus by reporting all income you get from your bank bonuses or side jobs, whether it’s in the form of money, property, or services.
Now let’s say you open a bank account and receive airline miles as an incentive. In this case, the cash value of the miles (which will be determined by the bank that offers them) is taxable, says Ashcraft. This is because, unlike a situation where you’re earning airline miles by using a travel credit card, no financial transactions were required in this case.
Staying ahead of the game
Whether you’re a fan of bank bonuses or credit card rewards, the key to making the most of these offers is knowing whether they’re taxable or not and planning accordingly. And if you have to pay taxes on bonuses worth more than $600, expect to receive a 1099 form in the mail and wait to file your taxes until you receive it.
With credit card rewards, on the other hand, you’re free to earn and burn without worrying about the tax man — that is, as long as you made a purchase to earn them. If you feel like you pay enough taxes already (don’t we all?), this could make redeeming your rewards that much sweeter.