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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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Persons desiring to buy round trip first-class tickets... similar to those to which the petitioners were entitled, would have had to pay $2,220 for them. The petitioners, however, were not such persons. The winning of the tickets did not provide them with something which they needed in the ordinary course of their lives and for which they would have made an expenditure in any event, but merely gave them an opportunity to enjoy a luxury otherwise beyond their means. Their value to the petitioners was not equal to their retail cost.... The problem of arriving at a proper fair figure for this purpose is difficult.44 A theoretical solution to this problem would be to allow taxpayers to determine the value of the tickets themselves, and tax them based on this amount. However, the obvious problem with this approach is that it opens the door for rampant tax evasion. Certainly, given the unfortunate and astounding amount of tax evasion every year, individuals likely would be inclined to lie and drastically undervalue the worth of the credits to

42. See Garsson, supra note 4, at 989 (indicating that consumers may fly first class only as a result of a bonus program which would render the value of the first-class ticket an inaccurate measure of their accession to wealth).

43. Turner v. Comm'r, 13 T.C.M. (CC) 462,463 (1954) (finding that the face value of a trip won as a prize was not equal to the value realized by taxpayers).

44. Id.

2002] FREQUENT FLYER CREDITS themselves.45 This would result in unwanted litigation and related expenses that the Service would want to avoid. Litigation would be complicated by problems of proof involved in trying to determine the real subjective value of the tickets to taxpayers-for example, how is the Service expected to ascertain such value? This subjective standard certainly does not provide a viable solution to the valuation problem.

Sharon Pouzar has offered a theory of valuation that seems to alleviate this problem of subjective valuation and resultant over-taxation.4 6 Pouzar argues that restricted or non-restricted frequent flyer tickets should carry no more value than a corresponding restricted or non-restricted ticket available for purchase at the time the free transportation is confirmed. 47 As a result, a value attached to a ticket redeemed through frequent flyer programs will never be more than the face value of the least expensive corresponding ticket available for purchase at the time of redemption. 4' The difficulty with this approach is that, by limiting the standard to only one airline, it does not overcome the possibility of inequitable results. The least expensive corresponding ticket available with one airline will, in many instances, be more expensive than a comparable ticket with another airline.

As a result, individuals will accumulate unequal measures of tax liability for what amounts to the same accession to wealth.

The only possible solution to enable Pouzar's approach to work would be to value the redemption at the amount of the cheapest corresponding ticket amongst all airlines. Nevertheless, not all airlines will offer a flight with the same "accession to wealth" as others. For example, 'Big Luxury' airlines will provide a more desirable flight than 'Bare Necessities' airlines.

To attach the same value to both just because they offer flights to and from the same destination on the same dates would be foolish. 49 In addition, any standards put forth to determine the comparative value of the flights will invite debate, as subjective considerations will necessarily play a role in

45. Based on IRS figures as of 2000, tax evasion has increased by sixty-seven percent in the last eleven years and represents about 22.5% of the amount of taxes collected. See Fundamental Tax Reform: Hearing before the Comm. on Ways and Means, 106th Cong.

106-115 (2000) (statement of Leo E. Linbeck, Jr., Chairman, Linbeck Corporation, Houston, Texas and Voluntary Chairman, Americans for Fair Taxation, Houston, Texas).

46. See Pouzar, supra note 4, at 75 (outlining Pouzar's proposed method of valuation).

47. Id. at 76.

48. Id. (illustrating that Pouzar's method of valuation results in valuing frequent flyer credits at fair market value).

49. This argument is not inconsistent with the earlier "inequitable results" argument.

See infra discussion at Part V. There are situations where the face values are different, but the actual flights are comparable, and there are situations where the face values may be the same but the flights are not comparable. In both situations, one individual incurs a tax liability that is not proportionate to his or her accession to wealth. This apparent inconsistency in language only serves to highlight the difficulties inherent in attempting to create a uniform, yet equitable, valuation method based on fair market value.

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reaching this type of decision.

–  –  –

Valuing the frequent flyer credits received by an employee at the resale value of the credits also involves insurmountable complexities. The secondary market is created when an individual cashes in his or her miles for a "flight voucher" and, in turn, sells this voucher. This transaction usually involves a middleman called a coupon broker.50 Analysis of this valuation method must begin with the assumption that these credits can, in fact, be sold.' Once this is established, the amount at which these credits can be sold will also have to be ascertained. This amount, which is likely to be substantially less than the redemption value of the credits, would be the amount a taxpayer would be required to include in his or her gross income.





The major problem with this approach is that it may not accurately reflect the amount by which an individual's wealth has actually been increased by receipt of these credits.53 This is due to the fact that secondary markets severely undervalue the credits. The very reason that the secondary exists is that purchasers benefit from the reduced prices. Thus, such a valuation, which is vulnerable to subjective market assessments, usually fails to accurately measure an individual's true accession to wealth.

In addition to this difficulty there is the danger of increased tax evasion. Individuals will be inclined to underreport what they received in the secondary market transaction. In the absence of a completely regulated secondary market, monitoring of the exact amounts of each transaction is impossible.

50. See Belden, supra note 38, at E6. (describing how frequent flyer credits may be sold or exchanged rather than redeemed).

51. See supra note 8, at 39 ("The sale, purchase, assignment or DELTA AIR LINES, INc., barter of Delta SkyMiles Award Travel Certificates and Tickets has been held to be illegal."). But see Harvey D. Shapiro, Buying Miles Is Thrifty - But Iffy, L.A. TIMES, Mar. 9, 1995, at D5. (asserting that individuals will likely be able to sell their miles if they so wish, at the burden of overcoming program restrictions or barriers, and at the risk of engaging in what may constitute illegal activity); Milking the System-Barterer Beware! Buyer Be Scared, November 1999, FLIER available at

INSIDE MAGAZINE,

http://awardtraveler.com/pgl 1.htm (last visited Feb. 19, 2002) ("Illegal may be a bit of a misnomer because this practice is against program rules, but not necessarily against the law.").

52. See, e.g., Milking the System, supra note 51.

53. Compare the tax consequences of a situation in which an employer gives an employee a new automobile costing $50,000. See Comm'r v. Duberstein, 363 U.S. 278, 278 (1960) (discussing the tax consequences of employer gifts). If the employee turns around and immediately sells this automobile for $2,000, clearly this amount does not accurately represent the employee's accession to wealth-the former transaction does.

20021 FREQUENT FLYER CREDITS

Value of Other Items Redeemable 3.

Currently, major airlines have cooperative partnerships with other companies from which individuals can earn flyer credits towards purchases with the cooperating entity. While the vast majority of these programs work "one-way" (i.e., credits may only be accumulated for redemption with the airline, not the cooperating entity), some partnerships work "twoway. ' 54 Though small in number, there is nothing to say the amount of such two-way programs will not grow. In addition, an individual who pays for business travel with an American Express, or similar credit card, for which he is enrolled in the Rewards Program or similar incentive program, has two options. The credits he accumulates may be converted into flyer credits with a participating airline,55 or redeemed for one of many "gifts" offered under the Rewards Program.

The problem with valuing credits based on the redemption item is figuring out which redemption item to use. While possession of a particular number of credits may allow for the purchase of various gifts, basing the valuation of the credits on the fair market value of the redeemable gifts may pose a problem. For example, it might take 5,000 credits to purchase any one of ten items, but it is unlikely that all ten items have the same exact fair market value. Indeed, participating programs may very well offer items of superior value for the same amount of credits as items of inferior value. Such offers could be the result of an inside arrangement or bulk discount that the furnisher of the item provided to the program. In addition, the program's own available supply of, or the consumer demand for, the goods or services could influence such determinations. Thus, it may not be possible to determine the actual purchasing power of the credits until they are actually used.

It would also be error to assume that the participating program has accurately assessed the fair market value of the item. For example, it is entirely possible that a participating program may assign a value of one hundred dollars to an item that can be purchased elsewhere for seventy-five dollars. 7 To value, and thus tax, the price designated by the program could

risk inaccurately inflating an individual's accession to wealth before or

54. See, e.g., Hilton Hotels Corporation, supra note 39 (citing examples of specific partnership agreements).

55. See, e.g., DELTA AIR LINES, INc., supra note 8, at 8-9 (naming airlines that participate in the Rewards Program).

56. See, e.g., American Express - Membership Rewards, supra note 39 (explaining how miles may be traded in for gifts).

57. Indeed, it would be in the programs' best interests to label the goods or services with the highest possible fair market value. The higher the perceived value of the redemption, the greater value the individual will place on the transaction, and want to stay with the service.

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after redemption.

Furthermore, the fact that these "two-way" programs are recent developments precludes an exhaustive analysis of the phenomenon. It is probable that these programs will expand in both number and services, and that this expansion will cause more complications than can be currently predicted. The above analysis, therefore, should serve to illustrate inherent difficulties involved in attempting to value flyer credits based upon redeemable non-flight goods and services.

4. Two Alternative, but Flawed, Proposals for Valuation

Commentator Lee S. Garsson has suggested that two methods which are found in the Treasury Regulations provide a solution to the complexities inherent in the airlines ticket-pricing scheme. 58 Regulation § 1.61-21(g) is called the "Noncommercial Flight Valuation Rule" and establishes a guideline for taxing an employee for the benefit he or she receives when provided with a personal flight on an employer-provided aircraft.59 The method establishes a "cents-per-mile" rate plus a terminal charge for such flights taken. The rate and terminal charge are set by the Department of Transportation and result in liability to each individual in the same proportionate amount.60 In addition to Garsson's proposal, Dominic Daher has proposed the following system 61that substantially mirrors the Regulation endorsed by Garsson: "I recommend the valuation of all employee [credits] at $.01 per [credit]... [where] employees would simply multiply the number of employee [credits] used for personal travel throughout the year by the factor $.01, and include that amount in gross income." 62 However, both Garsson's and Daher's interpretations of the Noncommercial Flight Valuation Rule fail for the same reasons. First, they do not account for the fact that credits may be redeemed for non-flight items, thus imposing a valuation method that is not comprehensive.

Second, while the method provides for an easy computation, it fails to make an accurate estimation of an individual's true accession to wealth.

58. See Garsson, supra note 4, at 989-92 (discussing the "Commercial Flight Valuation Rule" and the "Noncommercial Flight Valuation Rule").

59. Treas. Reg. § 1.61-21(g) (2001).

60. For example, if the established rate were $.05 per mile, individuals redeeming flights including travel of 100 and 500 miles, respectively, would have taxable income of $5.00 and $25.00, respectively.

61. Daher's proposal, the "Daher Standard," differs from the Regulation in that it applies to credits used for private travel as opposed to miles traveled. In addition, it sets a slightly lower amount than that currently offered in the Regulations and fails to assess the terminal charge found in the Regulations.

62. Daher, supra note 4, at 18.

20021 FREQUENT FLYER CREDITS Rather, it merely provides an arbitrary standard that does no more than sacrifice accuracy for simplicity's sake. Such an arbitrary compromise by the IRS would likely be met with disapproval. In addition, the arbitrary character of the method would only be exacerbated by any attempt at application to non-flight items.



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