Bank rewards programs: A tax information-reporting conundrum
Form 1099-INT, Form 1099-MISC or no requirements for bank rewards?
In recent years, the proliferation of bank rewards programs coupled with a relative dearth of legislative or administrative guidance has created an information-reporting conundrum for financial institutions and their customers. Banks use reward programs to promote certain business objectives, such as generating new accounts or incentivizing the use of a bank credit or debit card. Unbeknownst to some, rewards can trigger information return reporting requirements for the bank while constituting taxable income in the hands of the depositor. The facts and circumstances of the specific reward program generally dictate whether the financial institution has to send Form 1099-INT (1099-INT) or Form 1099-MISC (1099-MISC) to the IRS and reward recipients, who must receive the forms by Jan. 31. The due date for a financial institution to submit the IRS copy depends on whether the forms are mailed or filed electronically. While some fact patterns produce relatively clear answers, the reporting requirements for many others are not free from doubt. Inasmuch, banks should analyze which of the following filing requirements apply to a particular program:
- Neither Form 1099
Banks contemplating new rewards programs, as well as those with programs already in place, would be prudent to evaluate (or re-evaluate) any potential information reporting requirements. Analyses of existing programs may unearth gaps in the current reporting process and any associated penalty exposure. Penalties for failure to file required information returns, such as Forms 1099, can reach $100 per filing, up to a cap of $1.5 million. However, if a taxpayer intentionally disregards the rules, penalties increase to $250 per Form 1099, with no maximum penalty. Along the same lines, prospective programs can also benefit from proactive analyses to prevent, or at least minimize, unwanted compliance burdens and risks related to required information returns.
Tax information reporting considerations
Before delving into the nuances of 1099-INT and 1099-MISC, it is important to note the distinction between (1) certain taxable incentives, and (2) nontaxable incentives such as rebates or purchase price reductions. Common examples of nontaxable incentives include frequent flier miles offered by airlines and sale prices or other discounts offered by retailers. Nontaxable incentives can also exist in the banking context, but only in uncommon circumstances where the award is not tied to a bank account. As such, the following analysis focuses on the implications of rewards or incentives that fall beyond the scope of nontaxable rebates, such as programs associated with a bank account, and therefore may trigger requirements to file either 1099-INT or 1099-MISC.
In general, all interest totaling at least $10 per person in a given year must be reported to the IRS and the recipient via 1099-INT. This filing threshold is far more inclusive than the $600 needed to trigger a 1099-MISC filing requirement. If a bank can structure rewards of a 1099-MISC nature, it could substantially reduce the number of Forms 1099 the bank might be required to issue. Yet, the unfortunate reality in the bank context suggests that many rewards will generate 1099-INT filing requirements because of the connections between the award and an underlying bank account.
Financial institutions must evaluate each program on its own merits to determine which, if any, information returns must be filed under IRS guidelines. Because facts and circumstances vary widely, it is impossible to provide a laundry list of programs that result in either a 1099-INT or 1099-MISC. However, some examples may shed light on the issue. If a bank offers a $50 reward for opening an account with a deposit of at least $100, it will have to provide 1099-INTs to the depositors receiving the rewards. For other iterations of reward programs, such as a reward for using a direct deposit feature a certain number of times, the link to the underlying bank account may not be as obvious as in the previous example. While cash payments in respect to deposits are clearly interest income, other noncash items or gifts resulting from the opening of an account also fall under the interest income umbrella. Assuming the noncash gifts are not de minimis, as described below, the bank would have to issue a 1099-INT to the IRS and the recipient.
Certain de minimis premiums excluded
Certain incentives that do not meet the definition of a nontaxable rebate can, nonetheless, avoid the reach of the 1099-INT requirements. The exception covers certain de minimis, noncash inducements offered to depositors who open a bank account. However, two criteria confine its scope:
- The exception is only applicable to noncash benefits
- The value of the incentive must be less than $10 for a deposit of less than $5,000, or less than $20 for a deposit of at least $5,000
Even so, for applicable de minimis, noncash amounts, the ruling benefits both the bank—by alleviating the Form 1099 filing requirement, and the taxpayer—by allowing the benefit to be excluded from gross income on the taxpayer’s return.
Banks may be required to report on 1099-MISC payments not classified as interest. An example of a reward program that could trigger a 1099-MISC filing requirement is where a bank offers a certain number of reward points with a value of at least $600 for referring a friend to the bank. In this example, since no deposit is required by the customer making the referral, the payment does not rise to the level of interest. Alternatively, in a more likely scenario where the value of the points is less than $600, the bank would not have to send 1099-MISC. For example, a program that offers a $25 reward for enrolling in online banking, with no minimum required deposit, would not generate a 1099-MISC filing requirement.
While aggregate annual award amounts under $600 per recipient allow the bank to bypass sending a 1099-MISC to the IRS and the award recipient, it does not technically absolve the recipients from including the value of the reward in gross income on their tax return.
Simply put, banks do not operate in a bubble with an endless supply of customers; if they did, banks would not offer incentive programs in the first place. Instead, the industry landscape is inherently competitive. As such, banks should consider how competitors deal with Form 1099 reporting questions. That is not to say that a position taken by a competitor in this regard would be justification for disregarding the tax rules. Rather, the tax implications attendant to competitive award program choices are just one factor worth considering. The fine print governing reward programs is typically readily available on a bank’s website, among other places. Well-informed bank decision-makers, as well as consumers, can benefit from this transparency. Some banks’ fine print states that a 1099-INT or a 1099-MISC will be issued if the requisite dollar value thresholds are met.
It remains to be seen if banking industry groups or associations will push the IRS to clarify the guidance in this area, or at least opine on a set of accepted industry standards for some of the common fact patterns that suffer from a lack of guidance. The general trend towards more stringent Form 1099 reporting requirements suggests, at least for the moment, that favorable guidance from the IRS may be unlikely. At the same time, if the tax reporting begins or continues to place an undue strain on the recordkeeping systems employed by the financial institutions or requires instituting new ones, a renewed push by banking organizations for clarity or to alleviate some of the burden may be advisable.
Banks that manage to structure a program in a way that alleviates a Form 1099 filing requirement could actually gain a competitive advantage over a largely comparable program structured in a manner that yields a Form 1099 filing obligation. The potential benefit here is two-fold: internal bank resources can be deployed elsewhere, and depositors will like the fact that they do not receive a Form 1099. Further, the bank avoids possible feelings of resentment a customer could harbor upon receipt of an unanticipated Form 1099.
Banks should consider whether they have the infrastructure in place to handle additional Form 1099 reporting. As banks can easily have thousands of accounts, if not more, the capabilities of the current infrastructure and the feasibility of making any necessary improvements to it warrant consideration. An honest look at the associated cost of issuing significant quantities of new Forms 1099 can help in deciding whether the benefits of attracting and retaining customers outweigh the business costs of the additional compliance burden. A prospective depositor might wish to receive a reward even if it means paying some tax, as opposed to receiving no reward at all. This thought process highlights that although tax reporting requirements warrant consideration when structuring (or re-structuring) reward programs, they are only one factor among various other economic and strategic considerations and should not be weighted so heavily that they distort the overall business objectives of the bank.
Financial institutions that have or are considering initiating cash or noncash reward programs should carefully consider any associated Form 1099 filing requirements, as well as the tax impact to the depositor. Many times careful structuring can minimize or even eliminate the reporting burden for both the bank and account holder. For existing programs, particularly where no Forms 1099 have been filed to date, reinvestigating possible requirements can go a long way towards mitigating business risk, including penalty exposure.