«Darrell L. Oliveirat I. INTRODUCTION It has been over twenty years since the advent of frequent flyer programs at major airlines.' Yet, the Internal ...»
THE TAXABILITY OF FREQUENT FLYER CREDITS
EARNED BY EMPLOYEES: WHY THE IRS HAS
REMAINED SILENT ON THE ISSUE
Darrell L. Oliveirat
It has been over twenty years since the advent of frequent flyer
programs at major airlines.' Yet, the Internal Revenue Service ("IRS" or
"Service") has left unsettled the controversy surrounding the taxability of credits earned by employees through these programs. This inaction is surprising given the following factors: (1) well-established taxation principles found in code and case law that seem to warrant IRS intervention in this area2 and (2) the well-known nature of the IRS to tax everything within its powers.3 Indeed, the IRS has not turned a fully blind eye to this controversial topic; in a 1985 notice of proposed rulemaking regarding the implementation of regulations pertaining to employee fringe benefits,4 the t A.B. 1996, Princeton University; J.D. 2002, University of Pennsylvania Law School. The author would like to thank Professor William C. Tyson for his many insights and suggestions.
1. Kathryn Symmes Hall, Note, FrequentFlyer Benefits: Substantive and Procedural Tax Consequences, 20 IND. L. REv. 823, 824 (1987).
2. See discussion infra. at V.A.4.
3. See, e.g., Jennifer A. Cunningham, Note, Are Frequent Flyer Benefits Really Benefits?: An Analysis of the Frequent Flyer Tax Debate and a New Theory of Taxability for FrequentFlyer Benefits, 47 CLEV. ST. L. REv. 281, 281 (1999) (citing George Guttman, IRS Moves Slowly on Frequent FlyerIssue, 38 TAx NoTms 1309, 1309 (1988)).
4. Note that while some commentators argue that frequent flyer credits should not be includable in gross income because they fall under one of the I.R.C. § 132 exceptions for fringe benefits, this comment does not address that issue. For an in-depth analysis of why these exceptions do not, in fact, apply to the case of frequent flyer credits, see Dominic L.
Daher, The ProposedFederal Taxation of FrequentFlyer Miles Received FromEmployers:
Good Tax Policy But Bad Politics, 16 AKRON TAx J. 1, 7 (2001) (stating reasons why frequent flyer miles do not fall under the I.R.C. § 132 exceptions); Lee S. Garsson, Frequent Flyer Bonus Programs:To Tax or Not To Tax-Is This The Only Question?, 52 J. AiR. L. & COMMERCE 973, 973 (1987); Sharon Alice Pouzar, Note, Frequent FlyerAwards as Taxable Income: Time to Pay the Taxman, 5 TEx. WESLEYAN L. REv. 55, 66 (1998). In addition, for [Vol. 4:3
644 U. PA. JOURNAL OF LABOR AND EMPLOYMENT LAW
IRS made the following solicitation:
Comments are also requested relating to the tax treatment of socalled "bonus" programs (such as "frequent flyer" programs) under which a company provides benefits (such as free flights, automobile rentals, and hotel rooms) to their customers on the basis of the amount of business the customer does with the company. The issue of tax treatment arises when, for example, the business that gives rise to the benefits or bonuses is paid for by the customer's employer rather than the customer (i.e.
business flights or hotel rooms are paid for by the employer and the company awards the free flight or hotel room to the employee). Comments are requested on the need for special rules relating to the valuation of the benefits, the administrability of either withholding on or reporting the value of such benefits, and the appropriate party to charge with the responsibility for Comments are specifically requested regarding reporting.
the benefits should be regarded as "wages" subject to whether withholding. 5 Despite the abundance of persuasive commentary that has been contributed in response to this solicitation, the Service has chosen to remain passive on the issue and, consequently, no formal tax treatment of frequent flyer credits earned by employees exists today.6 The purpose of this comment is to explore the different considerations that best explain why the Service has not chosen to tax flyer credits earned in the employee context. Such considerations include various technical difficulties and policy complications. In addition, this examination will embrace the widely accepted concession that credits earned through private activity should not be taxed.
Part II provides an overview of the mechanics of frequent flyer programs and the redemption of credits. Part III outlines pertinent tax principles and provides a framework for the current status of the debate surrounding this controversial issue. Part III supports the proposition that, theoretically, credits earned by employees should be taxed, and Part IV provides an analysis of what is considered the most relevant case on the topic, Charley v. Commissioner. In Part V, the focus shifts towards issues an analysis of why such credits do not constitute I.R.C. § 102 employer/employee gifts, see Daher supra at 11, Garsson supra at 973, and Pouzar supra at 62.
5. Taxation of Fringe Benefits and Exclusions From Gross Income for Certain Fringe Benefits 50 Fed. Reg. 52,333, 52,334 (proposed Dec. 23, 1985). Note that the proposed regulations offered no treatment for frequent flyer credits, and that the only mention thereof was in the above solicitation.
6. According to Dominic Daher, the Service officially withdrew all plans to tax employer-provided frequent flyer miles in 1988. See Daher, supra note 4, at 18.
7. 91 F.3d 72 (9th Cir. 1996).
20021 FREQUENT FLYER CREDITS surrounding a practical application of the relevant tax principles.
Deference to existing commentary in this article is limited to theoretical applications of tax law in this context. While most commentators have chosen to sound an aggressive call to arms in support of the taxation of these credits, Part V explains why the IRS has been correct in taking a position of silence on the matter. In support of this argument, Part V emphasizes the complications inherent in the mechanics of frequent flyer programs, including valuing, monitoring, and timing issues-all of which present difficulties to a tax levy. Part VI then surveys different policy considerations, some that undermine, and some that support, the position of non-action by the IRS, and Part VII provides an historical framework of action by the Service to date. Finally, the comment's conclusion summarizes why a passive approach by the IRS is warranted, and leaves open for discussion the possibility of congressional action on the issue.
OVERVIEW OF THE FREQUENT FLYER CREDIT ACCUMULATION ANDII.
REDEMPTION PROCESSThe mechanics of frequent flyer programs are relatively simple. An individual usually calls an airline and requests to sign up for that airline's frequent flyer program. The airline representative creates an account for the individual and mails account information as well as information on how to earn and redeem flyer credits. Under current programs, such credits may be earned through a wide variety of commercial activities. These include the purchase of flights, car rentals, cruises, hotel use, bus travel, credit card usage, electronic stock trading, real estate transactions, telephone use, The standard flower purchases, and a multitude of other activities!
is for the individual to present his or her frequent flyer procedure membership account number when paying for any of the above-mentioned items.9 When enough credits have been accumulated for the individual to redeem a flight,' ° that person can usually contact the airline via the Internet, telephone, mail, or in person, to request a voucher or ticket for airline travel."
APPLICATION OF TAXATION PRINCIPLESI.
Section 61(a) of the Internal Revenue Code dictates that gross income
8. See, e.g., CONTINENTALAIRLINES, INc., ONEPAss PROGRAM GuiDE 2-8 (Aug. 2000);
DELTA AIR LINEs, INc., SKY MILES MEMBERSHIP GUIDE & PROGRAM RULEs 6-9 (2001).
9. See DELTA AIR LINES, INc., supra note 8, at 29.
10. The type of flight redeemable will vary with the amount of credits accumulated.
See, id. at 13-16.
11. Seeid. atl7.
646 U. PA. JOURNAL OF LABOR AND EMPLOYMENT LAW [Vol. 4:3 is "all income from whatever source derived.' 2 This has been construed by the courts to mean "accessions to wealth, clearly realized.., over which the taxpayers have complete dominion."' 13 Indeed, this broad conception has withstood scrutiny in the context of would-be gifts, 14 punitive damages, 15 treasure troves, 16 and even a unique situation involving the use of frequent flyer credits. 7 This treatment begs the question: If the definition of taxable income has been so broadly conceived, why doesn't the IRS tax frequent flyer credits? In the case of credits earned through the private purchase of flights (i.e., personal travel), the answer is simplethere is no income realized. Rather, the individual is getting the benefit of his or her bargain in an ordinary market transaction. Put another way, the price of an airline ticket can be seen to reflect the value of the flight and the value of any credits accumulated as a result of purchasing the flight.'8 Some refer to this characterization as a volume discount approach, others call it a mere reflection of market value. 19 Under either theory, the purchaser uses his or her own money to purchase the tickets, and the credits are accumulated as part of that purchase. Therefore, such an acquisition of credits cannot be described as "income" or an "accession to wealth."
In the employment context, however, something quite different occurs. An employee books a flight using his or her own money, and flyer credits are added to a personal account the individual keeps with the airline to accumulate credits for travel taken with the airline. The employer later reimburses the employee for the expense of the flight, and the employee keeps the credits. What distinguishes this from the case involving personal travel is that here the employee is not getting the benefit of his or her bargain. Rather, he or she is getting the right to retain these credits which
12. I.R.C. § 61(a) (2001).
13. See Comm'r v. Glenshaw Glass, 348 U.S. 426, 431 (1955) (holding that money received as exemplary damages for fraud or as punitive antitrust recovery constitutes gross income).
14. See Comm'r v. Duberstein, 363 U.S. 278, 278 (1960).
15. See Glenshaw Glass, 348 U.S. at 426.
16. See Cesarini v. U.S., 296 F. Supp. 3, 3 (N.D. Ohio 1969) (holding in favor of the United States in its action to tax treasure troves).
17. See Charley v. Comm'r, 91 F.3d 72, 72 (9th Cir. 1996). This case is examined in further detail below. For now, it is only important to note that the Ninth Circuit court did not address the issue of whether frequent flyer credits earned as an employee were taxable.
18. For example, an individual might ordinarily be willing to pay $375 for a round-trip flight from Philadelphia to Boston. However, given the prospect of gaining 2,000 frequent flyer credits on a reputable airline in addition to the right to travel, the purchaser may be willing to increase the amount of consideration paid for the round-trip ticket from $375 to $400.
19. See Jonathan Barry Forman, Income Tax Consequences of Frequent Flyer Programs, 26 TAX NOTES 742, 742 (1985) ("Frequent flyer programs are basically just complicated discounts for the purchase of multiple airline tickets.").
FREQUENT FLYER CREDITS2002] can later be used to gain travel and other airline benefits.20 Essentially, the employee is getting something for nothing. However, this something represents a clear accession to wealth and would therefore appear taxable under the principles of federal income taxation established by the Internal Revenue Code and accompanying case law.21 Nevertheless, neither the IRS nor the judiciary has chosen to take an affirmative stance on this issue. As a result, there exists no legal precedent directly establishing the taxability of these credits. In addition, the IRS has no enforcement policy in place that would call for the assessment of a tax on these benefits. The consequence is that taxpayers who earn these credits, in the course of what appears to be a taxable transaction, are free to continue using them without fear of tax liability.
IV. CHARLEY V. COMMISSIONER
The well-known and somewhat infamous case of Charley v.
Commissioneris the closest that either the Tax Court or the federal courts have come to deciding whether employee-earned frequent flyer credits are taxable.22 Indeed, it is the closest the Service itself has ever come to taking an affirmative stance on the issue. 2 While the case involved a "near miss" of the issue at hand, its precedential value lies in its illustration of the reluctance of the IRS, Tax Court, and federal courts to grapple with the difficult issue involved.
In Charley, the appellant, Dr. Phillip Charley, was the President of a company named Truesdail Laboratories (hereinafter "Truesdail"). 24 In the course of his employment, he was required to fly extensively for the company. When Dr. Charley flew, Truesdail's travel agent, Archer Travel Service, billed Truesdail directly for the cost of the flight. Truesdail, in turn, billed the client for this amount. Truesdail had an unwritten policy that frequent flyer credits earned by employees in connection with such business travel could be kept by the employees and would become their exclusive property.
20. See DELTA AIR LiNES, INC., supra note 8, at 12-16 (explaining Delta's "SkyMiles" redemption options).
21. See sources cited and text accompanying supra notes 12-17.
22. In tax litigation, a refund suit may be brought directly in a Federal District Court, and a deficiency suit may be appealed from the Tax Court to a Circuit Court. JAMES J.
FREELAND ET. AL., FUNDAMENTALS OF FEDERAL INcoME TAXATION 27-30 (10th ed. 1998).
23. The IRS defended its decision to assert a tax deficiency on appellant Dr. Philip Charley for the monetary benefit he derived from his use of frequent flyer credits.