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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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Another important topic related to the issue of timing is when, and whether, an employer should be allowed a § 162(a) ordinary and necessary business expense deduction for the cost of flights involving employee retention of frequent flyer credits. One author, Dominic Daher, argues that if flyer credits are to be taxable, then employers should not be allowed to take an I.R.C. section § (a)(2) travel expense deduction until the employee actually reports the credits as taxable income. 86 Daher bases his argument on purported general timing rules found in tax law, and he references, by way of analogy, the property transfer compensation provision of I.R.C. §

83. This provision holds that employers are not allowed to take a § 162 deduction until § 83 income is included by the employee.87 Daher's argument is flawed, however, because it falsely assumes that employers currently attempt to include as part of their deductions the value of the flyer credits. Although it would be questionable whether an employer should be able to take a § 162(a)(1) compensation deduction for the credits kept by employees, there does not seem to be any reason an employer should not be allowed to deduct travel expenses under § 162(a)(2). While § 83(h) simply makes general reference to § 162, § 83

84. See Pouzar, supra note 4, at 77 (proposing "that frequent flyer benefits be valued at the time they are redeemed for airline tickets").

85. For instance, if valuation is timed at redemption, then supporters of a valuing method based on amount received or receivable in the secondary market will effectively be preempted.

86. Daher, supra note 4, at 19.

87. I.R.C. § 83(h) (2001).

2002] FREQUENT FLYER CREDITS applies to property transfer compensation and, arguably, relates directly to the § 162(a)(1) compensation deduction.

Nevertheless, Daher's argument raises some interesting concerns that are best illustrated by the following example. Imagine that the cost of a business-related flight is $100. The employee pays for the flight, but later gets reimbursed for the full amount. However, the employee also keeps 1,000 miles which we will assume are valued at twenty dollars. The employer then takes a § 162(a)(2) deduction of $100 for the cost of the flight. Now, if the credits are taxable (as many argue), the employee must include the twenty dollars of credits as taxable income. However, the only reason the employee has the credits is because they were the employer's to give in the first place (i.e., they were property transferred as compensation).

So, in theory, the employer should also get a § 162(a)(1) compensation deduction in the amount of twenty dollars. However, this raises some obvious concerns because the employer appears to be getting $120 worth of deductions while only spending $100 in business expenses.

One solution to this apparent dilemma would be to have the employer include, as a taxable gain from dealings in property, the twenty dollars worth of flyer credits (i.e., the employer paid $100 and got a flight worth $100 and credits worth twenty dollars). Another solution would be to value the flight, and corresponding § 162(a)(2) deduction, at eighty dollars, thereby protecting the employer from having to report gain as a result of the ticket purchase. If we adopt the first approach-and tax an employer every time credits are received as part of a ticket purchase-then we assume that there is an unfair bargain between the employer and the airline (in which case the employer wins by twenty dollars). If we adopt the second approach, then Daher is at least partially correct in implying that employers have also been gaining a taxable benefit without tax consequence. In this case, they have deducted twenty dollars under § 162(a)(2) that should really be accounted for under § 162(a)(1).

If flyer credits are treated as taxable income, then the argument above illustrates added complexities that will have to be addressed. There will either have to be a determination of the value of the employer's allowable deduction, or acceptance of the counterintuitive idea that unequal bargains exist between employers and airlines. In either scenario, determining the tax treatment involves added difficulties for the IRS.


Outside of the realm of whether taxation principles call for the taxation of frequent flyer credits, and whether such taxation is practically feasible, an interesting and equally important question exists as to whether such taxation is warranted as a matter of general policy. One argument 664 U. PA. JOURNAL OF LABOR AND EMPLOYMENT LAW [Vol. 4:3 maintains that by continuing to turn a "blind eye" to the issue, the IRS is not only losing tax revenue, but is also inviting disrespect for the United States tax system that will encourage tax evasion. 88 However, this position appears to be overstated because inaction by the IRS in this situation will hardly be viewed as a laxity in tax enforcement. If nothing else, the present examination has shown the enigmatic character of these credits in the tax situation. While few would dispute that there is a clear accession to wealth involved in the redemption of these credits, it is also true that few would dispute the fact that barriers exist which make taxation in this situation difficult, at the least. It is clear that there are nuances involved in the taxation of frequent flyer credits that make it unfavorable for the IRS to take an affirmative, yet equitable, stance. This does not mean, however, that the IRS should be viewed as powerless to take action, thus warranting disrespect for the tax system. To the contrary, the inaction of the IRS should be viewed as a conscientious decision to avoid unfavorable taxation results.8 9 Furthermore, respect, or no respect, outside of the frequent flyer context, individuals caught evading taxes will still be subject to the same penalties and risks they always have. Unless one considers nonpayment of tax on credits redeemed as tax evasion (which is not really the case as the IRS has not made its policy on the issue clear), it is unrealistic to claim that tax evasion will increase as a result of IRS inaction. While taxpayers may be more inclined to take advantage of flyer credits, it is highly unlikely that the situation will also motivate them to illegally avoid the payment of taxes in other situations. It does not follow from the fact that the IRS has not taken a stance on the taxability of frequent flyer credits, that the IRS has discontinued policing tax evasion in general. Such an argument is illogical.

Nevertheless, the general sentiment is that there is something inherently wrong with allowing these credits to go untaxed. The benefits received through these credits are, in theory, an accession to wealth that should be subject to taxation. Even more troubling is the thought that this type of benefit is more accessible for wealthier individuals who hold wellpaying jobs that allow for such frequency in air travel. In addition, it is certain that such individuals will not shy away from the opportunity to gain these benefits. Quite to the contrary, one of the most attractive aspects of these credits is that the individual is basically getting something for nothing. This will allow the situation to self-perpetuate, as people do everything they can to obtain such a benefit. A somewhat ironic, if not

88. Aidinoff, supra note 36, at 1345.

89. See, e.g., 143 CONG. REC. E130 (daily ed. Feb. 4, 1997) (statement of Rep.

Kennelly) ("At a time when.., suspicion that the Internal Revenue Code is not fair and needlessly complex is at an all time high, it would be sheer folly for the Service to move in this area.").

2002] FREQUENT FLYER CREDITS amusing, fact drives this point home while also demonstrating that the airlines and their partners are all too willing to provide the means for

taxpayers to obtain these benefits:

Many people like to pay taxes with [credit card] not only for convenience but also to amass huge amounts of frequent-flyer [credits] or similar points in a hurry. Last month, one taxpayer charged $2 million of federal estimated income taxes.... The biggest individual payment by card last year was $7.2 million.... In a new twist, American Express says card members who use their cards to pay federal income taxes through April 16 can earn double [credits] on their Delta SkyMiles Card. 90 Nevertheless, blame for this problem cannot be placed on the IRS.

Although the Service does have the power to interpret and enforce the code, it cannot be forced to exercise this power in a situation where it is impractical to do so. For the IRS to take action would invite debate as to whether it has properly done so. This is not to say, however, that the Service has not attempted to tax these credits. The following section discusses these efforts to date.



For the last twenty-seven years, controversy has swelled around the taxation of non-statutorily excluded fringe benefits, and the IRS has indicated its inclination to tax them. For example, the Service issued a "Discussion Draft of Proposed Regulations" in 1975, which would have established the expansiveness of I.R.C. § 61 by clarifying which questionable compensatory items would be included in gross income 91 However, the Service succumbed to pressure from Congress, and withdrew the proposed regulations. In 1984, however, Congress passed the Deficit Reduction Act which expanded I.R.C. § 61 to specifically include fringe benefits in taxable income,92 and also added I.R.C. § 132, which provides some statutory exceptions for certain fringe benefits. 9 Nevertheless, this Act did not provide for specific treatment of frequent flyer credits. Then, in 1985, Proposed Regulations in the area of fringe benefits were again introduced, with an added solicitation of comments on the taxation of

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frequent flyer credits.94 However, these were also withdrawn.

Finally, a direct effort came in 1995 in the form of Technical Advice Memorandum (TAM) 95-47-001. This ruling by the IRS attacked the issue through the "back door" by effectively disqualifying employee reimbursement plans under § 62(c), which had allowed for employees to reap the benefits of frequent flyer credits accumulated on business travel. 95 By disqualifying the plans, reimbursement would effectively be treated as income to the employee. 96 However, due to a large public outcry, this position was eventually withdrawn.97 Yet, the culmination of these events resulted in at least one effort by Congress to treat the issue of frequent flyer credits specifically. In 1997, Congressional Representative Barbara B. Kennelly introduced a bill that called for a specific exemption for frequent flyer credits. Representative

Kennelly stated:

I rise today to introduce legislation to clarify that frequent flyer [credits are] not taxable... in light of the Internal Revenue Service's position in technical advice memorandum 9547001, and despite the fact that technical advice memoranda only apply to a given taxpayer and set of circumstances, I feel a clarification is necessary.... This is one of those areas where taxation would raise a myriad of questions for which there is no single correct answer, such as appropriate timing... valuation... [and tracking].... Taxation of frequent flyer [credits] would only result in mindless complication and paperwork of nightmarish proportions for millions of Americans, the airlines, and the Internal Revenue Service. And the Service should realize this.

[The Service has] opened, closed, and reopened several projects to address the tax treatment of frequent flyer [credits] over the years, all to no avail.... My bill would simply explicitly say that frequent flyer [credits] are not taxable.98 Unfortunately, however, the bill has not been enacted, and there is no other legislation currently in place to address this issue.

Apart from the question of congressional action, it is clear that the Service should not move forward in this area. There is a fine line that the

94. Taxation of Fringe Benefits and Exclusions From Gross Income for Certain Fringe Benefits, supra note 5.

95. I.R.C. § 62 (c) (2001); Treas. Reg. § 1.62-2 (2001); Tech. Adv. Mem. 95-47-001 (Nov. 24, 1995).

96. See generally I.R.C. § 62 (providing for deductions from gross income in calculating adjusted gross income).

97. See, e.g., FrequentFlyer FeathersFly, at http:llwww.tax.orgltaxaltadiscus.nsf/ 8525624b005f2cae8525624a0064a42b/0658247b293e1 17c852562840063fda8?

OpenDocument (last modified Nov. 24, 1995) (reporting that the IRS was reconsidering some of the analysis in the Technical Advice Memorandum 95-47-001).

98. 143 CONG. REc. E130 (daily ed. Feb. 4, 1997) (statement of Rep. Kennelly).

2002] FREQUENT FLYER CREDITS IRS would need to negotiate to enforce tax policy in this situation without creating tax policy. Such a decision is better left to Congress, which not only has the power to write into tax law special treatment for these credits, but is also the proper authority for consideration of policy issues.

Therefore, the obvious and workable solution to this dilemma is to place the burden on Congress to introduce and push forward statutory treatment to this problem in the form of a specific taxation approach, or an overall exception. In either case, part of the congressional role is to enact law riddled with policy issues. Indeed, included in the tax code's provisions are numerous instances where one party receives a tax benefit that another does not. 99 Regardless of what action is merited, it is clear that this policy burden should not rest on the shoulders of the Service. Rather, the approach is for Congress to decide.


The benefits employees gain through frequent flyer credits earned through business travel clearly constitute taxable income. However, given the complexities that would be involved in any action by the Service to tax these benefits, it is no wonder that the Service has not taken action.

Problems involved with valuing, monitoring, and timing the receipt of these credits involve a choice between many flawed alternatives which often lead to inconsistencies or inequitable results. As a result, there is no feasible approach to enforcing the taxation of these credits that will result in a fair treatment to all taxpayers. However, to continue to allow individuals to obtain benefits as a result of employment but not to tax them is contrary to tax principles and inherently wrong. Therefore, congressional action must be taken to settle this issue through direct treatment-whether this results in an exemption or a specified approach to taxation of these benefits.

99. For example, interest deductions for college graduates are allowed but not for credit card users. I.R.C. §§ 221, 163(h) (2001).

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