Mention the Internal Revenue Service (IRS), and it’s not surprising that you get reactions that range from terror to fear and confusion. To say that the U.S. tax code is convoluted is putting it mildly.
Even economists and tax experts agree that “The American tax code is a mess.”
Is it really necessary for our tax codes to be so complicated? If it’s inefficient, inequitable, and gives people a chance to get away with “fibbing” on their tax returns, shouldn’t those in power make changes?
The reason it’s so complicated is that it is:
“…filled with myriad deductions and exclusions that Americans can take for engaging in certain activities, such as buying a home, saving for retirement, and paying down student loan debt. Rather than spending money directly by subsidizing or providing these things, the government instead places incentives in the tax code for individuals to engage in these activities in private markets.” – Fortune.
At its most basic level, you’ll pay taxes based on the following formula: the amount of money you receive throughout the year minus any legitimate deductions. Your gross income minus deductions is the amount you’ll be responsible for paying tax on.
According to the IRS website:
“If you are a U.S. resident, you must report all interest, dividends, wages, or other compensation for services, income from rental property or royalties, and other types of income on your U.S. tax return. You must report these amounts whether they are earned within or outside the United States.”
Taxable and Non-Taxable Income
Again, using the IRS website as our go-to source, we dug into how they define income. Gross income can be received “in the form of money, property, or services.”
This can include:
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- Salaries
- Wages
- Self-employment income
- Unemployment income
- Fair market value of bartering of property or services
- Commissions
- Strike pay
- Rental income
- Rental income from an Airbnb for more than 15 days
- Alimony
- Royalty payments
- Stock options
- Dividends
- Interest
Then there’s any income from “fringe” benefits — even if it’s your spouse, not you, who receives them.
You may consider them a perk, but the IRS considers them income:
- A company vehicle for personal use
- A company-paid off-site gym membership
- Cash or gift certificates from your employer
- Bonuses and awards
- Severance pay
- A portion of employer-paid dependent care
- Company-paid tuition fees (over a certain amount)
- Company-paid financial counseling fees
- Employer-paid group life insurance (over a certain amount)
One more category: miscellaneous income. This may not obviously look like income but generally must be included on your tax return and can include:
- Gifts over $16,000
- The fair market value of property received for your services
- Crop insurance proceeds over $600
- Forgiven loans
- Scholarships that pay for other than tuition, fees, and books
- Disability retirement payments from an employer-paid plan
- Payments for fish or other aquatic life over $600
- Selling sperm
- Sickness and injury payments from an employer-paid plan
- Property and services for which you bartered
- Fishing boat proceeds over $600
- Money and income from offshore accounts
- Buried treasure
- The remaining amount of a debt or loan that is canceled or forgiven
Probably the least-followed tax rule ever is one that says you need to report and pay taxes on income made from illegal activity.
De Minimis (Minimal) Benefits
If your boss gives you a gift (a product or service) and the cost of it is so small that even the IRS thinks it would be unreasonable for them to include the amount in their accounting, you don’t have to declare it as income.
Other benefits that don’t need to be declared are:
- Discounts at company cafeterias
- Cab fares home when working overtime
- Occasional personal use of an employer’s copier
- Company picnics
If your employer gives you a turkey, ham, or something else of “nominal value” at Christmas or other holidays, it’s not necessary to include the value of the gift in your income. But, if they give you cash, a gift certificate, or something you can easily exchange for cash, the tax department expects you to include the value of that gift as an extra salary or wages, regardless of the amount involved.
Frivolous Arguments
There’s an entire section on the IRS site called The Truth About Frivolous Arguments. This section deals with “Contentions” and gives the IRS’ response along with endless case law examples to make sure you know how “frivolous” this contention is viewed by the might of the U.S. government.
- Translation: Don’t think you can sneak anything by the IRS.
- Contention: The filing of a tax return is voluntary.
This contention covers an argument some taxpayers use to say that they don’t have to file federal tax returns because the Form 1040 instruction book says that “the tax system is voluntary. To bolster their claim, these same taxpayers quote Flora versus the United States, 362 U.S. 145, 176 (1960), for the proposition that “[o]ur system of taxation is based upon voluntary assessment and payment, not upon distraint.”
Right. The IRS shuts this contention down hard and lets you know that the word “voluntary” has nothing to do with you having a choice whether to or not to declare your income and pay taxes on the net. The way they use the word “voluntary” is meant to refer to the U.S. tax system of letting you (the taxpayer) have the first crack at calculating the right amount of tax you owe.
In contrast to letting the government determine how much tax you owe them from the start. Clearly, that’s better for us, as we’ll be more sympathetic and creative than any government agency.
To make sure you understand how serious they are about this, they go on to add:
“Any taxpayer who has received more than a statutorily determined amount of gross income in a given tax year is obligated to file a return for that tax year. Failure to file a tax return could subject the non-compliant individual to civil and/or criminal penalties, including fines and imprisonment.”
They tighten up any creative loopholes with reams of information on frivolous arguments like:
- The Meaning of Income: Taxable Income and Gross Income
- The Meaning of Certain Terms Used in the Internal Revenue Code
- Fictional Legal Bases
- Invalidity of the Assessment
- Tax Court Authority
But with all this wealth of information on the IRS website, it’s still not clear if you need to declare rebates, points, and rewards as income and pay tax on them.
Does it Matter if I Don’t Report All My Income?
The short answer is yes.
Working for cash “under the table” is:
“…illegal and could result in prison time… Paying cash in order to get away without paying tax is a federal crime. If audited, an employer can expect to pay back all the money owed, along with interest, penalties and fines, and to be subjected to criminal convictions.”
Even if the work done is babysitting, yard work, or bartending. The IRS probably won’t come after your 12-year-old babysitting for the neighbor down the street, but they’re very clear that if they audit someone and find they’ve been involved in work done under the table, their tax problems become the recipient’s tax problems.
But back to the question at hand — rebates, points, and rewards, taxable or not?
Rebates, Points, and Rewards
It’s just as confusing as the rest of tax codes and laws and comes down to how the IRS defines the rebates, points, and rewards. It matters who offers them and whether the IRS considers them to be income or not.
It also seems to matter where they come from. Rebates or rewards that come from your bank or credit card company aren’t necessarily treated the same as rebates or rewards that you may get from a car dealership after buying your next vehicle.
If the rewards are viewed as a rebate or a discount, it’s not taxable. The IRS puts these in the category of “post-purchase discounts.” The rule of thumb here is when you “spend money to get something,” it’s tax-free. Like the rewards you get with most credit card programs.
But, if you sign up with a credit card that offers a large sign-up bonus, the IRS could consider the bonus taxable as an incentive, not a post-purchase rebate.
Another limit the IRS puts on tax-free rewards is how much you have made this way during a calendar year. If the total amount is over $600, Uncle Sam wants a piece of it, and you’ll need to fill out a Form 1099-MISC.
To give you some context, if you have a 2% cash-back program, to get a rebate/rewards check for more than $600, you would need to have spent $30,000 in a year. That’s a lot of frozen pizzas.
Don’t ignore your credit card company if you get a Form 1099-MISC. The IRS is taking more of an interest in making sure to get their rightful tax cut and has begun to track income from these sources. At the very least, get some advice from a tax expert before you shred the form.
Cash back (or cash-back) started to get popular around the turn of this century. It’s related to credit and debit cards and is actual cold, hard cash that you get as a reward for spending money.
Think Costco. If you upgrade to an Executive Membership, you’ll get 2% cash back on every purchase you made in the last year, paid out in February. They’ll actually send you an old-school check. Unless you specify (and you can), the check will be made out to Costco, so you’ll use it there.
If you use their Costco Anywhere Visa card, you’ll get 4% cash back on eligible gas and EV charging purchases for the first $7,000/year (1% after that). You can earn 3% cash back on restaurants and “eligible travel purchases.” You’ll earn the same 2% cash back on all your Costco and Costco.com purchases and 1% cash back on everything else.
The point isn’t to entice you to get a Costco membership; it’s to point out that you can earn a significant amount of money from a program that offers a cash-back reward.
Most credit and debit cards offer this feature and, as of this year, offer to direct deposit the money to a linked bank account. Or you can use the money to reduce your current statement in the form of a gift card or get a check in the mail.
If you have a business credit card, it’s best to subtract the reward amount from a specific business purchase. For example, if you purchased an office printer for $489.74 and your credit card offers 2% in rewards, deduct the 2% from the sale price and use that reduced figure on the accounting of your legitimate expenses.
When it comes to a points rewards program that doesn’t involve an “exchange of cash,” you don’t need to worry about including them on your tax return. If you receive “travel miles, accumulated points toward future purchases, and reward discounts automatically applied as balance credits,” you won’t need to pay any tax.
What if You Get Audited?
If the mention of the IRS makes people nervous, just drop the term “IRS audit” into the conversation and watch the group back up. No one wants to be audited, and most people find just the idea nerve-wracking.
In 2021, over 160 million individual income tax returns were filed, and 659,003 were audited. That works out to 0.4% — four out of every 1,000 files.
First of all, it’s crucial to know that the IRS will never call you. One of their biggest concerns is the uptick in scammers calling the public and pretending to be the IRS. If you get a call like this, hang up immediately and report the call by emailing [email protected] or calling 800-366-4484.
If there’s a discrepancy in your tax return, you’ll get a tax notice by mail asking for more information about certain items on your return, like income, expenses, and itemized deductions. Clear that up, and it’s over.
If you did make a mistake, you can pay any tax and interest due. Done. If they determine to audit your return fully, you’ll only pay the penalty if the IRS shows that mistakes were due to negligence or fraud.
For negligence, the penalty is 5-20% of the additional tax due. For fraud, something done knowingly and willingly, the penalty is 75% of the tax owed. Cases of extreme fraud can be treated as tax evasion, for which it is possible to be prosecuted and sentenced to jail.
The rabbit hole of the IRS can suck you in and take up hours of your time or send you off to sleep as a cure for insomnia. The best advice is to be honest with your income and deductions and get advice from a tax expert when you’re not sure.
Claudine is the Chief Relationship Officer at Level 6. She holds a master’s degree in industrial/organizational psychology. Her experience includes working as a certified conflict mediator for the United States Postal Service, a human performance analyst for Accenture, an Academic Dean, and a College Director. She is currently an adjunct Professor of Psychology at Southern New Hampshire University. With over 20 years of experience, she joined Level 6 to guide clients seeking effective ways to change behavior and, ultimately, their bottom line.
