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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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The other bright-line approach, found in Regulation § 1.61-21(h) is called the "Commercial Flight Valuation Rule" and applies to fringe benefit commercial flights. This approach values flights that employees receive for free from their employers at twenty-five percent of the carrier's highest unrestricted coach fare in effect for the particular flight taken. 64 Garsson asserts that application of this type of formula in the frequent flyer context would not undervalue awards as the "highest unrestricted coach fare exceeds the super-saver considerably, and most personal travelers take advantage of the latter." 65 While this also provides a simple method of valuation, it presents the same problems inherent in the fair market valuation approach discussed earlier. 66 Because this approach makes no effort to determine accurately an individual's accession to wealth, such a system will likely lead to inequitable outcomes. The result often will be that taxpayers will have different tax liabilities for what amounts to the same flight.

Furthermore, application of the principle to the highest fare for all carriers also produces arbitrary results. In cases in which two similar airlines offer comparable flights, different pricing approaches could plausibly result in large discrepancies. For example, on September 30, 2001, Expedia.com (a discount travel website service) listed two round-trip flights from Boston to Philadelphia, leaving October 19 and returning October 21. The price of the first flight, a "bargain fare" was $160.00 while the price of the second, a regular discount fare, was $775.00.

Twenty-five percent of $775.00 is $193.75; $33.75 more than the price of another flight on the same day. For an individual placing no preference for one flight over the other, the result of the Commercial Flight Valuation Rule would gauge the taxpayer's accession to wealth above the amount for which that person could conceivably have obtained the flight.

Of course, one could argue that there may be ways to avoid this dilemma such as setting a ceiling on the amount taxed to correspond to the lowest ticket price available. However, the need to tweak the Commercial Flight Valuation Rule only serves to demonstrate an inability to determine accurately the appropriate amount of taxable income.

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A final problem involved in the taxation of frequent flyer credits involves the simultaneous use of credits earned through personal travel and through reimbursed business travel. For example, an individual may set up a frequent flyer account with an airline and then take a few flights on personal travel, accumulating credits in the process. Subsequently, such a taxpayer may take a few flights related to business travel for which the taxpayer is reimbursed and receives frequent flyer credits, at which point the taxation question comes into play. If the taxpayer later redeems all of the credits accumulated in the account, valuation becomes complicated under almost any method. First, the IRS will need to determine what credits will be considered taxable, and what credits will not be taxable.67 Next, under whatever scheme of taxation is adopted, the IRS will need to develop a solution to ensure fairness as well as effectiveness. Thus, the use of personal credits with business credits undoubtedly serves to further complicate the issue.68

B. MonitoringProblems

The mechanics of frequent flyer programs also offer complexities for reporting purposes. When posed with the question of who is to report the accumulation or redemption of frequent flyer credits, the only reasonable answer is one of the three parties involved-the employee, the employer, or the airline. However, each of the three involves problems unique to that party's position in relation to the overall scheme of these programs.

The first possible reporter, the employee, carries a high risk of tax evasion. As discussed above, 69 individual taxpayers are the least likely to comply with reporting requirements.70 In the absence of a system that will compensate for the well-founded assumption that individuals will undoubtedly misconstrue the amount of frequent flyer benefits redeemed, taxation of these credits will prove unenforceable. 71 As a result, taxation in

67. This involves monitoring problems discussed infra Part V.B.

68. See also Kanter et al., supra note 34, at 34, ("As a practical matter, however, the valuation of frequent flier [credits] is very difficult-if not impossible.... The problem is compounded by the fact that [credits] are not 'tagged,' i.e., a frequent flyer [credit] earned on employer-paid travel looks the same as one earned from employee-paid travel.").

69. See discussion infra Part V.A.1.

70. See Hall, supra note 1, at 853 n.273 (citing tax code provisions demonstrating a congressional intent to subvert widespread tax evasion).

71. This assumption is further bolstered by the fact that many individuals have had 2002] FREQUENT FLYER CREDrrS this context will be inefficient.

Another approach is to have the employer, who is responsible for taxwithholding and reporting to the IRS, to also report the benefits realized by employees. This argument makes sense if one considers the benefits as part of income received from the employer. While, in essence, this is true, the practical fact is that the benefits are received directly from the airline.

As a result, the employer is not typically knowledgeable with respect to the amount of miles accumulated, or the benefits redeemed. Thus, the ability of such employers to ascertain and report the value of credits used by employees would at best be questionable, and would undoubtedly depend on airline cooperation. It would therefore seem unduly burdensome to place this responsibility on employers, who would incur substantial costs in accumulating the information that would be reported to the IRS.

Most commentators support placing the reporting burden on the airlines. Such arguments appear persuasive, given the fact that each airline must keep records of the accounts of individuals participating in such programs in order to effectively monitor the use of such credits for internal purposes. These records include the dates the credits were accumulated, the amount of credits accumulated, dates on which credits will expire, identification of the account holder, and information concerning redemption.7 4 Nevertheless, contrary to some commentators' arguments, it would be an impractical and unfair burden on the airlines to require reporting on their part. First, they would need to implement systems that effectively differentiate between miles earned on reimbursed business travel, and miles earned through personal use. The necessity for this differentiation is based on the fact that the commingling of such miles will prevent proper taxation. 7s Second, in the case in which employees pay for business travel out of pocket, and then seek reimbursement, it would be necessary for the employers to contact the airlines to ensure proper categorization of the credits. This would require some legwork on the part of the airlines in tracking the flight taken, the applicable credits, and how they were distributed. Otherwise, an employee could conceivably tell the airline the twenty years to become accustomed to receiving frequent flyer benefits as an untaxed fringe benefit.

72. See Hall, supra note 1, at 854 ("Because employers cannot track the employee's use of frequent flyer bonuses without excessive cost in order to reclaim the bonuses from the employees, it would be impossible to require an employer to track the bonuses for reporting purposes.").

73. See id. at 854.

74. See, e.g., CoNTiNENTAL AIRLINEs, INC., supra note 8 (describing the earning and use of frequent flyer credits); DELTA AIR LINES, INC., supra note 8 (describing the mileage credit procedures).

75. See Canter et al., supra note 34, at 319; Daher, supra note 4, at 19.

660 [Vol. 4:3


flight is for private activity, receive the credits without worry of tax consequence, and subsequently receive reimbursement from the employer.

This is only further complicated by the fact that an individual may take a flight for both pleasure and business, thus confusing the issue of how many credits should be attributable to business travel for taxation purposes.76 These monitoring burdens placed on airlines would be substantial and unfair. They would effectively require reporting by airlines as if they were employers themselves.77

C. Timing Difficulties

Upon a determination that frequent flyer credits earned on employee travel should be taxed, an interesting question arises as to when an individual has experienced an accession to wealth for taxation purposes.

Such a determination will be important not only for determining the existence of tax liability, but also for determining the amount of such liability. There are two possibilities for such timing: (1) when the credits are earned or accumulated; and (2) when the credits are redeemed or used.

Note also that the second possibility, determining tax liability by the point at which the credits are used, will involve choices between (1) when an award is filed requesting redemption, (2) when a voucher is received, (3) the date the voucher is used to purchase an airline ticket, or (4) the time at which the actual trip is taken.78 Strong arguments exist which support taxation at the point the credits are redeemed or used as opposed to when they are earned or accumulated.

First, to choose, for timing purposes, the date such credits were earned or accumulated would be to invite debate as to whether the taxpayer actually has received the benefit being taxed. Taxation at this point in time would involve the problem of determining when an individual has constructive receipt for taxation purposes. This would involve determining when the taxpayer has effectively taken control of such credits so as to experience an accession to wealth.79 Second, and as a matter of equity, the argument is

76. See Canter et al., supra note 34, at 319 ("Numerous technical questions must be answered if the IRS wishes to broadly attack frequent flyers. For example... [i]f the frequent flyer takes a trip for both business and pleasure, how would the frequent flyer miles be characterized and allocated?").

77. Cf.Daher, supra note 4, at 19. Also, note that this discussion does not reach the further difficulty of "double-dipping." For example, if an employee purchases a business flight with a credit card with which miles or credits may be accumulated, and also receives miles or credits from the airline, the monitoring concerns now extend to an additional party and the burden increases.

78. See Garsson, supra note 4, at 973 (discussing the IRS notice of proposed rulemaking and request for comments concerning the tax treatment of frequent flyer bonus programs).

79. See Treas. Reg. § 1.451-2 (2001) ("Income although not actually reduced to a 20021 FREQUENT FLYER CREDITS lucid-great numbers of individuals will never redeem all of the credits earned. These unused credits, as a result, will be forfeited.80 To tax an individual for the possession of credits that will never be used, and therefore never trigger an accession to wealth, would be inconsistent with taxation principles.81 Third, taxation timed at the date credits are accumulated or earned would lead to valuation problems and cause inequitable results. This is because different airline programs require different credit accumulations for redemption of essentially the same flight. 82 Taxing a person based on accumulation of credits alone would likely mischaracterize such person's accession to wealth.

A different question arises, then, as to what type of action should constitute the redemption of these credits. First, of the possibilities mentioned above, one can be disposed of immediately-the time at which the trip is actually taken. Prior to this point, the taxpayer has already received a benefit representing an accession to wealth. For example, subsequent use of a new car received from an employer does not determine whether there has been an accession to wealth, receipt of it does. 3 Similarly, the use of a flight received as a benefit is immaterial as to whether there has been an accession to wealth, at what point this accession has occurred, and what value has been received.

Second, to time the accession or valuation at the time "when an award is filed requesting redemption" would also be flawed. At this point, the mere filing of the request does not reduce the benefit to possession any more than the period during which the credits are held in an account for the individual. Indeed, the status of these credits is no different than the point at which they are eamed-a possibility, which we have seen, is insufficient for a determination of timing.

Of the two possibilities left, the more favorable for timing purposes is when the credits are redeemed (i.e., when a voucher is constructively received by the taxpayer). Such an approach has been endorsed by Sharon

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Pouzar as the fairest, and most practical method. 4 Indeed, it avoids the problems involved with constructive receipt and expiration. Furthermore, unlike the last possibility-"timing at the point at which the voucher is used to purchase a ticket"-timing at the point of redemption is more workable with any situation involving a secondary market sale of rewards. This is because valuation will not depend on any amount received in the secondary market, but on what the value of the redemption was.

Unfortunately, however, even this approach to timing concerns will not alleviate the problems inherent in valuation and monitoring. As a result, inequitable results will still be bound to follow. In addition, uniform agreement as to whether this is the correct point for timing purposes is far from attainable. Different theories of valuation and monitoring concerns will necessarily influence one's decision as to the timing question. This is because the determination of timing will necessarily affect the viability of valuation theories,85 and will also lead to increases or decreases in the burdens placed on monitoring parties. As a result, the method of timing supported above does little to support an argument favoring action by the IRS to tax these benefits.

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