Some frequent flier miles are taxable, Citibank says

Frequent flier miles aren't so enticing when they're taxable.

That may be the sentiment among Citibank customers who are receiving 1099 tax forms from the bank to report their frequent flier miles. The forms were sent to customers who were given American Airline miles for opening a checking or savings account last year.

That's causing confusion — and possible concern — among those who never before reported their frequent flier miles and other credit card rewards as income.

Here's what's behind the seeming discrepancy:

The confusion
Credit card rewards — including frequent flier miles and cash back — are not taxable because they're treated as rebates on spending, according to the Tax Institute at H&R Block.

However, a reward given for opening a checking or savings account is not considered a rebate since you don't spend any money to receive it. So the gift is instead treated as interest income, meaning that it's taxable.

Smaller gifts, such as mugs, aren't reported by banks. But an iPad or other pricey gifts are reported.

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Those are the guidelines Citibank says it's following; the bank confirmed that its credit card customers aren't being required to report their miles or other rewards as income. The bank says the forms were sent only to customers who received miles as part of the promotion for opening an account. And those customers will need to report the miles as income since Citibank is notifying the IRS regardless.

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"When a customer receives a gift for opening a bank account — whether cash, a toaster or airline miles — the value of that gift is generally treated as income and subject to reporting," the bank said in an emailed statement.

The background
A representative for Citi declined to say the dollar value it placed on the miles given to customers in the promotion. But on Monday, U.S. Sen. Sherrod Brown, a Democrat from Ohio, called on the bank to stop treating the frequent flier miles as income. Brown noted that Citi "arbitrarily calculates the value of each frequent flier mile as 2.5 cents."

For 25,000 miles, that would amount to $625 in taxable income. And given the stingy yields on checking and savings, customers likely didn't earn close to that amount from the accounts they opened.

Citi says the tax implications were disclosed in promotional materials. But the promotional brochure provided by the bank only notes the tax stipulation in a footnote in a dense "terms and conditions" section.