Consumers unhappy to find some rebates are taxable

Last year, Jane Kuhl and her husband qualified for a state-run program that promised a 50 percent rebate to homeowners installing energy-saving insulation.

The couple spent more than $6,700 plugging holes and insulating their Harford County farmhouse, which was originally built in the late 1800s. For their work, they received a 35 percent rebate from the state, along with a 15 percent rebate from their utility. Happy at first, they were later surprised and disappointed to find out that they owe income taxes on the $2,461 received from the state.

"This is the first time I have heard of a rebate being taxable," says Kuhl, a 55-year-old retiree. "I have been getting rebates all my life, but no one has ever taxed it."

Welcome to the confusing and quirky world of rebates and taxes. Some rebates are taxable; others aren't. And which is which is not always crystal clear — which can trigger some ugly surprises. Some Citi customers, for example, were shocked recently to discover that the frequent flyer miles they received for opening an account are taxable.

Basically, federal law says all income is taxable unless there's an exemption, explains Wally Eddleman, deputy director of the office of Maryland comptroller.

And rebates have quite a few exemptions, which is why many of us don't think of them as taxable.

A rebate isn't taxable if it's reducing the purchase price of an item or if it's a reward for meeting certain spending goals. So if a car manufacturer gives you a $2,000 rebate on a new auto, that's a price reduction and not income. And you don't have to pay taxes on cash awards, miles or points in exchange for making purchases with your credit card.

But Citi caused an uproar when it notified some customers that their air miles are taxable.

The bank last year offered 25,000 or more in American Airlines miles to people opening a checking or savings account. And last month, Citi sent those new customers federal 1099 forms that listed the miles as miscellaneous income. (Businesses that pay $600 or more to taxpayers in income other than wages must report this on the 1099. A copy also is sent to the IRS.)

Citi's move caused a panic among consumers, who feared that frequent flyer miles would now be taxed.

"When a customer receives a gift for opening a bank account, whether cash or a toaster or airline miles, the value of that gift is generally treated as income and subject to reporting," says Citi spokesman Sean Kevelighan.

The IRS agreed.

According to the Tax Institute at H&R Block, whether a reward is taxable or not depends on why you were given it.

Cash back or other awards to customers for spending a certain amount of money are not taxable, the Tax Institute says. But gifts, such as an iPad or concert tickets, awarded upfront to get you to open an account are taxable.

And the tax bite on some gifts can be sizable. Based on the price of miles consumers can buy on American Airlines' website, the value of 25,000 miles is $687.50. If this were taxed at the 25 percent rate, it would add about $172 to a tax bill.

"If I was going to respond to one of those ads to get 50,000 miles for opening a new credit card or other account, I would look at it really closely," says Abe Schneier, senior technical manager with the American Institute of CPAs.

(Don't worry, that mug your bank gave you for opening an account is too small to be tax-worthy, according to the Tax Institute.)

In Kuhl's case, the homeowner says there was no mention in the rebate terms that the money would be taxed when she applied for Maryland's Home Performance program. The Maryland Energy Administration notified her that the money might be subject to taxes only after the insulation work was completed, she says.

Kuhl says she found out for sure the money was taxable last month, when she received a 1099 form from the state. She didn't get a 1099 for the utility's share of the rebate, which amounted to about $959.

The homeowner says she bought the insulation with money out of her own pocket — on which she had already paid taxes. To be taxed again, she says, "significantly cuts down on the amount we saved."

I asked Eddleman with the state's comptroller office to explain what happened.

Eddleman says there is an exemption for utilities offering a rebate for energy conservation, and that's why Kuhl's rebate from the utility was untaxed. But there is no exemption, he says, for the state portion.

Marylanders who received a state rebate for under $600 won't receive a 1099. But Eddleman says they should report the income on their tax return.

This is all based on federal law, Eddleman adds. If Maryland legislators don't like it, they can always carve out an exception. They have before.

Several years ago, the state offered solar energy grants to homeowners that also turned out to be taxable, Eddleman says. Responding to complaints, Maryland legislators provided some relief by allowing taxpayers to subtract the rebate from the income reported on their state income tax.

Kuhl has her fingers crossed.

"If everybody complains," she says, "maybe they will look into it."