What Employers Should Know About Business-Related Frequent Flyer Miles

Fall has arrived — and, with it, one of the more active seasons for business travel. Perhaps your organization has employees heading to conventions, conferences, client meetings or other events in the coming months. If so, now's a good time to brush up on an easily overlooked tax question: What happens when employees earn frequent flyer miles while traveling on their employer's dime? The answer involves a long-standing IRS policy and important boundaries to keep in mind.

Enforcement Policy

Many employers allow employees to use frequent flyer miles earned on business travel for personal purposes. Indeed, this can be an enticing fringe benefit for salespeople and others who spend time on the road.

Generally, employer-provided fringe benefits are included in an employee's income and must be reported on Form W-2 unless the Internal Revenue Code provides a specific exclusion. But the IRS has historically struggled with technical and administrative issues related to frequent flyer miles.

For instance, which miles are attributable to business expenditures and which are personal? If miles do generate taxable income, how and when should that income be valued? Because of these issues, the IRS announced in 2002 that, as an enforcement policy, it wouldn't assert that taxpayers understated their federal tax liability because of the receipt or personal use of frequent flyer miles or other in-kind promotional benefits attributable to business or official travel.

The policy isn't strictly limited to airline miles. Similar considerations can apply to in-kind promotional benefits earned through business-related hotel stays, rental cars and other travel arrangements. Also, as of this writing, the IRS hasn't issued superseding guidance. The 2002 announcement stated that, if the policy is revised, any changes would be prospective.

Notable Exceptions

The IRS policy does have some exceptions. For example, it doesn't apply if travel or other promotional benefits are "converted to cash, to compensation that is paid in the form of travel or other promotional benefits, or in other circumstances where these benefits are used for tax avoidance purposes."

Taxable compensation paid in the form of travel could also occur if an employer uses frequent flyer miles to buy plane tickets to a vacation destination and then gives those tickets to an employee. But if your employees use accrued points to buy their own vacations, that would seem to fall squarely within the IRS policy.

The distinction between employee-earned rewards and employer-provided benefits can be important. If your organization controls accumulated rewards and intentionally uses them to provide personal travel or other benefits to an employee, the arrangement may warrant closer scrutiny as potential compensation that must be reported.

When Cash Comes Into the Picture

Credit card issuers have developed reward systems that are far more flexible than the frequent flyer programs at the center of the IRS policy. Some allow conversion of points into gift cards at a uniform rate or redemption of points for cash. Others bypass points altogether in favor of simple cash rebates.

Bottom line: Don't assume that the frequent flyer guidance also determines the tax treatment of credit card points, cash-back rewards or similar benefits associated with business purchases. Different considerations may arise depending on who earns or controls the rewards, how they're redeemed, and whether they're provided to an employee as compensation.

In addition, be sure to coordinate rewards policies with your organization's broader travel and expense procedures. Employees still need to properly substantiate reimbursed business travel expenses, regardless of any miles or points they earn from the trip.

Implement a Clear Policy

Under current IRS rules, the personal use of frequent flyer miles earned through business travel generally presents less of a federal tax concern than you might expect. However, the details still matter — particularly when rewards can be converted to cash or are provided as compensation.

Implementing a clear policy governing travel rewards can help your organization apply consistent practices and identify situations that warrant closer tax review. (See sidebar below.) Work with your tax advisor to develop or update such a policy, as well as to evaluate all of the tax and payroll implications of the rewards your employees receive.