Taxation of Credit Card Benefits

A few weeks ago I got a booklet in the mail from my credit card company. The booklet was sent as a reminder that I have a “credit defense” benefit on my credit card.

I pay a premium $0.39 per $100 of ending balance in my account. For that payment, I get to use a variety of benefits provided by the credit card company.

For example, if my wife or I were to get laid off or become disabled, the credit card company would make our minimum monthly payment each month for a certain period of time. Other benefits include reimbursements for medical expenses, car repair, taking the pets to the vet, and moving expenses.

I’ve never actually used any of these benefits, but I don’t mind paying the premium because I’m paranoid about sudden loss of jobs or becoming disabled.

At any rate, what are the tax consequences of these types of benefits?

I did quite a bit of research for this post, but turned up little when it comes to reimbursement of auto expenses, pet expenses and moving expenses. There is, however, guidance on the unemployment benefit part.

Let’s break this into two pieces.

One: Unemployment or Disability Payments

If you become unemployed or disabled and the credit card company makes your monthly payments for you, those payments are taxable if the payments exceed the amount of premiums you paid during the year.

This part is clear (see page 94 of IRS Publication 17).

Two: Reimbursements

What’s less clear is what happens if the credit card company reimburses you for things such as car repairs.

For example, under my credit card’s benefit program, they will pay up to $250 of car repairs once a year. The way it works is, I pay for the car repair using the credit card, and then the credit card company will issue me a credit on my account for up to $250. Same concept for medical expenses, pet expenses, etc.

I couldn’t find anything definitive about this, but I think this type of benefit is not taxable. Unlike with the unemployment/disability payments, these benefits are a reimbursement for expenses actually incurred.

The credit to the account does reduce the amount of credit card debt owed, but unlike in typical debt cancellation, this is not really an acquisition of wealth because it’s a reimbursement of an expense.

The only tax implication I can think of is if you’re reimbursed for a deductible expense. In that case, you would reduce your deduction by the amount paid by the credit card company.

Deducting Losses in Retirement Accounts

The general tax rule is that market losses in retirement accounts are never deductible. That statement is true, but as with everything relating to the taxes, there’s a “but.”

In rare circumstances, you might be able to deduct losses from these accounts.

Basic Requirements for All Types of Accounts

  1. All accounts of the same type must be fully paid out. For example, if you have 3 IRAs, all 3 accounts must be fully paid out.
  2. You must have after-tax basis. This means amounts put into the account with after-tax dollars. With Roth IRAs, your basis is whatever you have paid into the account. In traditional IRAs and 401(k) plans, your basis would be any non-deductible contributions you have made. Most 401(k) plans will never have non-deductible contributions in them.

The Mechanics of Figuring the Deduction
Assuming you meet the above two requirements, you then have to calculate your loss. To do this, you take the amount of cash you receive and compare it to your basis. If the cash received is less than your basis, you are eligible for a deduction.

Example: You close out a Roth IRA account. It is the only Roth IRA you have. Through the years, you paid in $5,000 into the account. You received $4,000 when you closed out the account. The amount of loss eligible for a deduction is $1,000 ($4,000 received minus $5,000 basis).

Hurdles to Clear
In the example above, you are still not in the clear for taking a $1,000 deduction. Tax law puts three hurdles in place that make it hard to actually take the deduction.

  • Hurdle #1: losses on retirement accounts are not considered capital losses. Instead, they are considered miscellaneous itemized deductions. This means: you only get the deduction if you itemize deductions.
  • Hurdle #2: because it’s a miscellaneous itemized deduction, the amount of the loss has to exceed 2% of your income in order to be deductible.
  • Hurdle #3: Only the portion of the loss that exceeds 2% of your income can be taken as a deduction.

Example: continuing with the above example of a $1,000 loss – if your income is $40,000, you take $40,000 x 2%, which equals $800. You subtract $800 from the $1,000 loss, which equals $200. You can put $200 as an miscellaneous itemized deduction on your tax return.

I Can’t Do Much to Help You Once the Transaction Is Completed

A professional in my network of contacts recently asked if I could help one of his clients. His client had sold some property for a large gain and was facing a tax bill of tens of thousands of dollars. According the professional, the client’s current CPA “had no suggestions” on how to make the tax hit go away, so he was hoping I could help.

It turns out, as it so often does with things like this, that the current accountant wasn’t an idiot, and I couldn’t do much to help either.

Why? Because this was in early May 2014, and the property in question had been sold in 2013.

Contrary to popular belief, there’s no magic that any accountant or tax preparer can work after something has been done, especially if the year has ended.

In this person’s case, he may have qualified for a 1031 exchange, but in order for a valid exchange to happen, the replacement property must be identified within 45 days of the sale of the old property. Since the sale happened in 2013 and it was now May 2014, that wasn’t an option.

And since the year had ended, things like selling other properties at a loss weren’t an option either.

Your accountant is not a magician. If you do something without asking for advice beforehand, and you end up with a big tax bill, and your accountant says there’s nothing that can be done … your accountant is saying that BECAUSE IT’S TRUE, NOT BECAUSE HE’S AN IDIOT.

The point is: the time to ask for tax advice about something that will generate a massive tax bill is beforehand, not afterwards.


Bedside Manner is Important for Tax Pros, Too

Late last December, I was having awful stomach pains. So bad that it hurt for my shirt to touch my stomach. I thought I had gallstones … or worse.

So I went to the local walk-in clinic and they did a battery of tests. They drew bloodwork and took x-rays.

All the tests came back fine. The doctor hurried in and said I just had “inflamed muscles” and I was quickly sent on my way with a prescription for heartburn medicine and an admonition to take it easy.

(Earlier this month, the pain came back and I went to a different doctor who diagnosed a hernia within literally the first 10 seconds of examining me.)

Anyway ….

When the nurse was drawing my blood, she went on and on and on about how she hoped it wasn’t anything to do with my pancreas, because that’s just really bad and she knows someone blah blah blah blah blah.

Yeah, lady. I know people who have had pancreatic cancer too. It’s scary. You’re diagnosed one day and oftentimes gone in months, if not weeks. That was certainly on my mind.

And this nurse didn’t help by blathering on about it.

And then the doctor, who was obviously in a hurry to move me along as quickly as possible, gave a lame “the x-ray showed inflamed muscles” diagnosis and sent me away with heartburn medicine. Six months later, I finally got a proper diagnosis from a doctor who took time to look for the right things. (The doctor also informed me that it’s not possible to see inflamed muscles from an x-ray. More proof the other guy was just trying to move me along.)

People talk about whether healthcare providers have good bedside manner. But it’s important for accountants and tax pros too.

Especially when delivering bad news.

My rules for delivering bad news:

  1. Do it by phone or in person
  2. Come to the point quickly — I will sometimes say that I have “bad news,” but I find it’s best to avoid the descriptors and just come out with it
  3. Understand that the client may not be happy
  4. If you can work in an explanation before the client says anything, do so. Otherwise, let the client respond and have their say before you proceed with an explanation
  5. Don’t try to break the tension with jokes. Even if the amount of money is relatively small, even a $200 tax bill is a big deal to most average folks, especially if they’ve never owed at tax time before.
  6. Don’t make flippant comments about the IRS or the government, even if you know that the client’s politics lean toward the Tea Party side of things. That sort of talk won’t change the client’s current situation.
  7. Explain the client’s options for paying the amount they owe
  8. Follow up with an e-mail so there’s written documentation

Each year, I have to make calls like this every now and then, and these are the rules I follow.


Baseball’s Replay System: Almost Perfect

Major League Baseball is using expanded instant replay for the first time this season. The new system allows managers to ask for a replay. The wikipedia entry on MLB instant replay explains it well:

(M)anagers will be allotted one challenge per game (two if the first challenge results in an overturned call) while the umpiring crew chief will be empowered to initiate a review in innings 7 and later. The umpires will also be allowed to review a home run call at any time, even during innings #1-6. Once a call is challenged an umpire requests a video review, fellow umpires in New York’s Replay Command Center will watch video of the play in question using the “indisputable video evidence” standard when deciding whether to overturn a call.

As with anything MLB does, the system has critics, but I like the replay system. It’s almost perfect.

The only thing I would change is the manager challenge part. That just seems hokey.

If the objective is to get the call right, then either team or any umpire should be able to ask for a replay on any play at any time, regardless of what inning it is or if a manager has “challenges” left. (I feel the same way about the use of replay in football, too.)