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«Darrell L. Oliveirat I. INTRODUCTION It has been over twenty years since the advent of frequent flyer programs at major airlines.' Yet, the Internal ...»

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However, the IRS conceded in its Tax Court brief that "'the tax treatment of frequent flyer bonus programs [was] still under consideration."' Charley v. Comm'r, 91 F.3d 72, 75 (9th Cir. 1996).

24. Truesdail provided laboratory testing services, including testing the urine of race horses and investigating the causes of industrial accidents. Id. at 73.

648 [Vol. 4:3

U. PA. JOURNAL OF LABOR AND EMPLOYMENT LAW

During 1988, Dr. Charley was able to make a monetary gain through the manipulation of frequent flyer credits accumulated in connection with his travel for the company. This gain was accomplished through a five-step transaction. First, a client engaged the services of Truesdail and directed Dr. Charley to travel to a particular site. Second, if Dr. Charley chose to travel by air, Truesdail billed the client for round-trip first class air travel.

Third, Dr. Charley instructed Archer Travel Service to arrange for coach service to and from the site, but to bill Truesdail for first class air travel.

Fourth, Dr. Charley used his personal frequent flyer credits accumulated largely through prior business travel for Truesdail, to upgrade the coach ticket to first class. Fifth, Dr. Charley then instructed Archer to transfer funds amounting to the difference between the cost of a first class ticket and a coach ticket to his personal travel account. The total value of these funds in 1988 was $3,149.93. Dr. Charley claimed that he had no idea that they constituted taxable income.

The Tax Court held for the IRS, finding that the funds transferred to the taxpayer's personal account constituted gross income.25 The Tax Court

stated:

There is no indication in the record that petitioners could not use the accumulated [funds in the account] for personal purposes nor, in fact, redeem the [funds] for cash on demand. There is no showing that Truesdail had any rights, interest, or control over petitioners' personal travel account. Whether we regard this fact situation as a straight "rip-off' by petitioner of his employer or a highly technical "sale" of his frequent flyer [credits](which have zero basis) for the [funds], the fact remains that petitioner was wealthier after the transaction than before. In such26 circumstances, the accretion of wealth is the receipt of income.

This opinion is relevant for two reasons. First, it emphasizes the fact that courts intend to treat clear accessions in wealth as "income from whatever source derived." 27 Second, while the Tax Court found that there was taxable income, it did not state whether this income was an employee fringe benefit, a constructive dividend, or gain realized from the distribution of property. In fact, it appeared to be completely irrelevant to the Tax Court's holding that frequent flyer credits were involved. 28 This omission is particularly conspicuous given that the issue of whether these credits are taxable had already been widely commented on and seemed ripe

25. Charley v. Comm'r, 66 T.C.M. (CCH) 1429, 1430 (1993).

26. Id.

27. I.R.C. § 61(a) (2001).

28. See Adam Rosenzweig, Employee-Owner of Company Taxable on Frequent Flier Miles "Sold" Back to Company: Charley v. Commissioner, 50 TAx LAw. 677, 681 (1997) (analyzing the Tax Court's decision in the Charley case).

2002] FREQUENT FLYER CREDITS for determination. Based on the combination of these factors, it is clear that the Tax Court must have been unwilling to address the issue of the taxability of frequent flyer credits in the abstract, and thus proffer a solution to the debate.

On appeal, the Ninth Circuit affirmed, finding that the funds in Dr.

Charley's travel account could be classified as compensation derived from his employer, or, alternatively, that the funds could be considered proceeds from the sale or exchange of the taxpayer's personal frequent flyer credits. 29 Under the latter approach, the funds would be treated as a gain Dr. Charley made on the disposition of his own frequent flyer credits and taxable under I.R.C. § 61(a)(3). ° Unfortunately, such reasoning did little to clarify the tax consequences, if any, associated with the accumulation or use of frequent flyer credits. Indeed, the Ninth Circuit was careful to sidestep such a

conclusion:

[T]he Charleys argue that no taxable event occurred.... [They] argue that this case raises the question of whether, in the abstract, frequent flyer [credits] constitute gross income. We disagree and do not reach that issue.... The fact that the [funds] were exchanged for frequent flyer [credits] simply is not relevant to the analysis.31 It is worth noting that the Ninth Circuit dismissed the notion that if the funds were treated as compensation to Dr. Charley from his employer, they could be exempt from taxation as gifts32 or as a non-taxable employment fringe-benefit.3 3 One may ask at this point whether, aside from giving peripheral attention to the use of frequent flyer credits, Charley has any value for the issue this comment addresses. The answer is a resounding yes. The case clearly demonstrates the reluctance of the IRS, the Tax Court, and the Ninth Circuit to address the taxability of frequent flyer credits. Indeed, each of these parties had the opportunity to do so: the IRS in its brief, and the Tax Court and Ninth Circuit in their decisions-if not as part of their reasoning, then at least as dicta. Instead, each chose to shy away from a topic that was, and continues to be, highly controversial. This leads us to the question of why has the issue been so avoided, and has this been an





29. Charley, 91 F.3d at 74.

30. I.R.C. § 61(a)(3).

31. Charley, 91 F.3d at 74. By concluding that the funds were taxable as employee compensation or, in the alternative, as a gain on the disposition of property, the Ninth Circuit effectively evaded the question of whether the use of frequent flyer credits could be treated as a taxable event.

32. See, e.g.,. I.R.C. § 102 (2001).

33. See, e.g., I.R.C. § 132 (2001).

650 U. PA. JOURNAL OF LABOR AND EMPLOYMENT LAW [Vol. 4:3 acceptable approach?

V. PROBLEMS INHERENT IN THE TAXATION OF FREQUENT FLYER

CREDITS DUE TO COMPLEXITIES IN THE MECHANICS OF FREQUENT

FLYER PROGRAMS34 There is little doubt that the taxation of frequent flyer credits earned on business travel would result in a tremendous increase in tax revenues by the Federal Government. There are approximately seventy Frequent Flyer Programs today worldwide with over one-hundred million members receiving over ten million awards per year.35 The possible added tax revenue figure involved with those credits earned through business travel is more than impressive. 36 However, the Service has chosen not to take advantage of this available stream of would-be taxable income. As will be discussed in the remainder of this comment, the reason for such lack of action by the Service can be only a result of practical difficulties involved in such taxation.

First, there is the problem of establishing standards for determining the value of the credits to be taxed. For example, the most widely considered proposals suggest that taxable credits should be measured by either, (1) the cost of a redeemable flight; 37 (2) the after-market resale value of the credits or flights;38 or (3) the cost of other items that may be purchased with the credits.39 Secondly, there is the problem of

34. For a myriad of related concerns, see generally Canter et al., How Not To Deal With Frequent Flyer Miles For Tax Purposes, 85 J. TAX'N 319 (1996) (discussing Charley and the conundrum frequent flyer credits pose for tax lawyers, and suggesting various strategies for tax lawyers who must deal with the valuation of frequent flyer miles).

35. Frequent Flier.com, A History of Frequent Flyer Programs-FFP'sToday, at http://frequentflier.com//ffp-005.htm# (last visited Jan. 23, 2002).

36. See M. Bernard Aidinoff, Frequent FlyerBonuses: A Tax Compliance Dilemma, 31 TAx NOTES 1345, 1347 (1986) ("Ever since frequent flyer bonus problems were introduced in the early 1980's, billions of dollars of free travel benefits have been received by passengers in connection with business flights."); Rosenzweig, supra note 28, at 677, (citing George Guttman, IRS Moves Slowly On Frequent FlierIssue, 38 TAX NOTES 1309 (1988)) (indicating that it was estimated that taxation of frequent flyer miles would have generated tax revenue of $200 million in 1988).

37. Note that the ticket price for a particular flight will vary throughout the year. The amount of credits needed to redeem the flight, however, will be set by the particular program's guidelines. See, e.g., DELTA Ant LINES, INC., supra note 8, at 13 (describing the Delta frequent flyer program's guidelines).

38. Note that a secondary market exists for the sale or exchange of these credits before redemption. See, e.g., Tom Belden, Business Travel: How to Propel Yourself Into First Class, PHILA. INQUIRER, Oct. 27, 1997, at E6 (describing how frequent flyer credits may be sold or exchanged rather than redeemed).

39. For example, frequent flyer mile credits may be used towards the redemption of hotel rewards. See, e.g., Hilton Hotels Corporation, Hilton Honors-EarnBoth Points and Miles, at http://www.hilton.com/hhonors/points/index.htmi (last visited Jan. 28, 2002). The 2002] FREQUENT FLYER CREDITS monitoring--or, more simply stated, the question of who has the ultimate responsibility for keeping track of these credits. The only reasonable possibilities are the parties involved in the transaction: (1) the taxpayer; (2) the employer; or (3) the third party airline. Finally, there is the problem of timing, i.e., the determination of the point at which these credits constitute taxable income. The two most commonly proposed points in time are: (1) when credits are accumulated and (2) when they are redeemed or used. An examination of these difficulties and the lack of effective solutions available lends support to an argument in favor of the Service's path of non-action.

Valuation ProblemsA.

The first complexity with taxing frequent flyer credits is determining the amount to be included in the taxpayer's gross income. The three most

commonly discussed possibilities are listed above. They are, essentially:

(1) the fair market value, or cost, of the ticket redeemable (2) the fair market value of the credits in a secondary market; and (3) the value of other items that may be redeemed with the credits. In addition, there have been two other methods proposed for valuing these credits that are worth exploring. The first is based on a specified value per mile or credit, and the 4° second on a percentage of the would-be flight cost.

Fair Market, or Cost, Valuation 1.

The first possibility, the value of a flight that can be redeemed, poses inequitable results if adopted as a uniform standard.4' For instance, assume that a taxpayer has a frequent flyer account with Delta Airlines, and that enough credits have been received to purchase a flight, round-trip from Boston to Philadelphia. Assume also that the taxpayer goes ahead and purchases this flight. Under this redemption or market valuation theory, the taxpayer will have accumulated added gross income totaling the amount of money it would take to purchase this flight from Delta.

However, it is likely that there are other airlines that offer the same flight (Philadelphia to Boston) with comparable amenities (including space, Hilton program is unique in that it permits a "double accumulation" which allows greater point redemption. In addition, an employee may use a credit card with a rewards program, such as that of American Express, to accumulate points through flight purchases. These points may be later redeemed for gifts or transferred to a frequent flyer account with a partner airline. See American Express - Membership Rewards (2001), available at http://home3.americanexpress.com /rewards/splash.asp.

40. See Garsson, supra note 4, at 989-91 (explaining valuation methods). See also Daher, supra note 4, at 18 (proposing a new valuation system for employee miles).

41. There are also the added timing difficulties, which are discussed below.

652 U. PA. JOURNAL OF LABOR AND EMPLOYMENT LAW [Vol. 4:3 refreshments, etc.), but at a cheaper price. Nevertheless, under this approach, taxpayers that have redeemed credits with these airlines for the same flight will actually be liable for less taxable income than our taxpayer that flies Delta on business. It would be inaccurate, however, to say that any one of the two has experienced a greater "accession to wealth" than the other. They have all received the same benefit, or increase in wealth, yet one individual would owe a greater amount of tax for it. Essentially, the factors involved in pricing such flights involve considerations so far removed from the taxation of the redemption of these flights, that taxation in this context would produce arbitrary results.

Another problem with the fair market valuation rule is that it may overstate the taxpayer's "accession to wealth." 42 For example, an individual may choose to redeem a flight for a date that the airline has severely overpriced its tickets, due to an anticipated high volume of travel, or for some other reason. The fact may be that the individual would never pay out-of-pocket anything near the current price of the flight. Therefore, it would be hard to say that the taxpayer's "accession to wealth" is equal to the face value of the ticket redeemed. Indeed, the Tax Court in the 1954 case of Turner v. Commissioner reduced tax liability based on this

subjective standard. 43 The Court stated:



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