Some stories are utterly fascinating and this is one of them.
The plot involves brilliant manipulation of consumer rewards offers, legal grey areas and all comes to a head with an IRS dispute over earnings from rewards points, which will likely shape the future of rewards and taxation.
It’s all about how a man earned $300,000 in actual cash rewards, thanks to a year of spending many millions on a rewards credit card by “spending without spending” – aka ‘manufactured spending’.
The wildly lucrative, morally contemplative practice drew the ire of banks issuing the credit cards and even more noteworthy, the Internal Revenue Service. But in a recent development the person was mostly vindicated, at least for now.
Man Earned $300K In Credit Card Rewards
Manufactured spending is the art of generating rewards without actually dipping into your income to pay for the transactions. You find a way to convert the purchases back into cash, so that you can pay your bill.
It typically involves using credit lines to buy simple monetary instruments like gift cards using a credit card, then using the gift card you just bought with a credit card to fund a money orders or similar option to deposit the funds into your bank, converting the credit card purchases back into cash so you can pay any credit card bills.
Say you have a $10,000 credit line, and buy $10,000 of gift cards using the credit card. You then exhaust an avenue to convert those gift cards back into something which can become cash, such as a money order, or deposit into an account which can be used to settle an Amex bill. You then use that money order or deposit to pay the $10,000 credit card bill, thus generating rewards.
With many cards offering up to 5X points on various transactions, that means millions of potential points, or cash back at hand.
During promotions for certain gift cards, where ‘fees’ are waived, or discounts are offered, such as buying a $1000 gift card for $900, it’s possible to achieve net even or better on the purchases, not even including the rewards points or cash back earned.
The cash back rewards earned are the big story in this particular drama.
Konstantin Anikeev, a rather brilliant computer science type effectively went to town on the manufactured spending game, using excellent credit and serious planning to drum up millions in charges on a rewards credit card offering unlimited 5% cash back at the time, after a certain amount of introductory spending.
With millions of dollars in transactions generated, without actually spending millions of cash, thanks to the process of churning the credit card transactions back into real cash, more than $300K in cash back was earned in a year.
Yes, the man effectively spent nothing and earned $300,000 real cash back dollars in rewards.
Put it this way, at 5% cash back, there’s $50 generated from every $1000 “spent”. When you spend millions and then convert it back to cash to pay the bills, it adds up, even if you incur $5-$10 transaction fees.
It would’ve been a brilliant place to the roll credits for someone winning the dubious manufactured spending game, but then the IRS got involved and rewards credit card companies too. The IRS saw the $300k in actual cash back earned as taxable, since it was “cash”. And that’s where it gets very complicated.
IRS Taxation On Credit Card Rewards
Typically, credit card rewards are not taxable. Therefore, if you spend a million dollars, like actually spend a million dollars, and earn 5 million points back, the IRS isn’t dinging you as if that 5 million points is income. It’s not income, it’s rewards, or a rebate.
Goods purchased are taxed, as is your income, so your rewards earned for being a savvy consumer and earning a good rebate are not.
But if you’re not actually spending money, and no actual “goods” are purchased, and you’re just effectively buying “money” or monetary instruments with a credit card, for the sole purpose of getting cash back, are you effectively creating income, rather than rewards? And doesn’t that sound to a novice like money laundering?
That’s where the debate can go well into the night, and is also a key reason banks are stepping up shutdowns on credit card accounts which constantly make ‘cash like’ transactions using their credit lines.
It’s all fun and games if a person is able to liquidate their credit card swipes back into cash, and yes, the credit card company does benefit from a swipe fee, but what if the merry-go-round all of a sudden comes to a halt? What if gift cards can’t be used for money orders, and so forth? Someone is left holding the bag.
Worse, what if it’s not for the purpose of generating rewards, but for the purpose of laundering money? At that point, a bank would have a customer, potentially with little to no actual income, who owes substantial amounts on their credit cards, which likely cannot be repaid in a timely fashion, or worse, the company has been party to illegal activity.
Like it or not, for risk management teams at these global brands, it’s often more than anyone is willing to stomach. Amex has been an early aggressor in the fight to curb manufactured spending, which can often look quite a lot like money laundering, both to the bank and to authorities and recently shut down numerous accounts.
Mostly Vindicated In US Court
Perhaps most interestingly, the consumer actually mostly “won” the case against the IRS, and won’t be required to pay tax on all the rewards earned, which sets significant precedent.
The court deemed that credit card rewards and other points are simply rebates and aren’t taxable, so nothing changed there – kind of. The judge, via a split decision also simultaneously ruled that buying money orders or reloading gift cards with a credit card could be taxable, according to The Street and WSJ.
It therefore was of the opinion that Mr. Andreev was on the hook for a portion of the rewards earned, based on the many purchases where he was simply purchasing monetary instruments specifically for the purpose of generating income, not goods.
If your shoulders are in a shrugged position, you’re not alone. It’s complicated.
Credit card programs, for their part, are looking to tighten rules or discouraging factors in rampant cash like transactions, for example, when you use a credit card to take out actual cash from an ATM, you pay a significant interest percentage.
It’s possible, due to the rife abuse similar transactions have experienced, that person to person payments may eventually be seen as the same, and interest owed would negate any potential benefits. That would ultimately be a sad day for those who don’t abuse the system, who would find fewer rewards and more hurdles down the line.
For now, Anikeev is a largely vindicated man, who made $300k in actual cash by using credit card rewards to maximum benefit, even if they weren’t as intended. The back taxes owed may put a downer on the earnings, but it’s still more than a quarter of a million earned.
Many market factors which enabled this rather insane story originating in 2014 have since been slashed, so it’s a bit of a ‘catch me if you can’ drama, but one that is only now setting precedent for future rewards, and their relationship with the IRS.