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Citibank frequent flier customers file lawsuit protesting Form 1099 filings

Some new Citibank customers got a shock when the financial institution sent them 1099-MISC forms listing a taxable value of frequent flier miles they got for opening their accounts.

Now those customers, many of them former customers if you believe their vows to sever ties with the financial giant, have sent Citi a surprise message of their own.

They've filed a class action lawsuit claiming that Citibank lured new customers into opening accounts by promising "free" frequent flier miles that actually cost them hundreds of dollars in taxes.

Citibank sign by kiwanja Flickr creative commons Photo by kiwanja/Flickr

Courthouse News Service (among others) reports that lead plaintiffs Bertram Hirsch and Igor Romanov are contesting the Citibank income reporting on several grounds.

Rehashing mileage miles tax issues: First, the Hirsch and Romanov say that Citibank did not tell them that they had to report 2½ cents per mile as income to the Internal Revenue Service. They say they only discovered this unexpected taxable income amount when they got their 1099s from Citi.

In fact, says the lawsuit:

"It is widely understood in the marketplace that airline miles are not reported to the IRS as being taxable for income tax purposes. Indeed, Citibank expressly informed Plaintiff Hirsch that the American Airlines miles that he would receive for opening up Citibank checking and savings accounts were not taxable."

This is going to be an interesting area of legal argument.

It's true that the IRS has since 2002 taken the position that frequent flier miles earned by customers are not taxable. They are generally viewed as rebates, i.e., cost reductions, not income.

That's the tax/no-tax position the IRS reiterated as the 1099 issue escalated.

Citi's position is that the frequent flier points are just like any other reward that a bank gives to clients for opening accounts. The bank says it's just following the tax law.

It's also worth noting that banks are heavily regulated, so they want to be careful to not make missteps that could cost them. Where this caution was during the subprime mortgage debacle is another matter, but let's not go back there again now.

Read the fine print: Also, Citi says that it was pointed out in the account application fine print that the customers would be "responsible for taxes, if any."

Yeah, yeah. We all should read the fine print of every contract before signing and that's what a financial account is, a contract. But few of us do.

Still, Citi seems to win on this point. Ignorance of the law is no excuse for not following it.

But, for the sake of argument, what did the fine print say?

The tiny type disclaimer for a current Citi $100 reward enticement for new account holders says, "The value of the cash offer will be reported to the IRS as miscellaneous income in the year received on Form 1099-MISC, as required by applicable law. Customer is responsible for any taxes."

Was the frequent flier point reward as specific? Did it expressly say that the mileage points would be considered taxable income and at what value? I would hope that the suing customers and their lawyers have looked at those account opening documents.

Value also at issue: But since this is a lawsuit, there are more claims. The class action lawsuit also is questioning the valuation amount of the miles.

"Even if the airline miles were taxable, Citibank's practice of valuing the airline miles at 2.5 cents per mile is grossly unfair and deceptive. Airline miles have no value to Citibank customers that can be fixed at the time they are awarded. If redeemed, these miles typically have an average value to customers of between .76 cents per mile and 1.2 cents per mile. At least one study recently concluded that American Airlines miles in particular are only worth about .76 cents per mile."

The plaintiffs want restitution and compensatory and punitive damages for unfair trade practices, breach of contract, negligent misrepresentation and unjust enrichment.

I absolutely love that unjust enrichment charge. If this claim flies, I think every major corporation in America will be a bit worried.

The plaintiffs also want a court to stop Citibank from making similar offers in the future.

Will the lawsuit proceed? Will Citi offer some sort of settlement to make it go away? Will the IRS come out with a specific ruling on this particular frequent flier instance?

Will you ever look at a "free" offer the same again?

Count the income: There won't be any resolution of the lawsuit before this year's April 17 tax-filing deadline, so folks who got a frequent flier 1099-MISC from Citibank should go ahead and report the income on their 2011 taxes.

Remember, the 1099 is an official tax statement and the IRS got a copy. If you don't include it in your income, the IRS will.

Sure, you'll get a notice of the proposed change, but despite your cries of unfair and entrapment, the IRS works off the various 1099s it receives.

Plus, given the growing federal deficit, the tax gap and the recent increase in tougher third-party reporting rules, you can bet that the tax agency isn't going to just blow off the added income.

So pay the taxes now and hope that a future court ruling will let you file an amended return.

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Great article! I am curious to get your take on why Citi felt obligated to file a 1099-C for such a small amount (in the example above $100). Aren't they required to report 1099 income for amounts of $600 or more?

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