ben hedges: irs taxes credit card rewards?! manufactured spending loophole closed

They spent $1.2 million on these things in 2013, and over $5 million in 2014. And through this method, they earned over $300,000 in extra income. Hey, credit warriors, welcome to the show. And have you ever partaken in the practice of manufactured spending on your credit card? Don't be shy. You know, the practice of buying gift cards and certain things like that, and then using those gift cards to pay your credit card bill. Sending that borrowed money round in a circle and accumulating some rewards in the process. No? Anyone? No? Oh, you have. Oh, okay. Did you know that it might get you in trouble with the law? You want to change your answer? Oh, you haven't now. Oh, that was just a joke just now you said that. Okay, well, that's good. Yeah, that's good that that guy just now didn't do it. Because a court here in the US has just ruled that profits from large-scale manufactured spending on credit cards are taxable. And when the IRS comes after you, it is really hard to get out of it. Take the case of Mr. and Mrs. Anikiev. This case pertains to their actions manufactured spending between the years 2013 and 2014. But it was only just resolved. So these two people both had American Express cards. And we're going to call this the old blue cash. It was an older version of this card. I found an article on how the reward system worked back then. You earn 5% cash at grocery stores, gas stations, and pharmacies. The card offers no annual fee. But you have to spend a minimum of $6,500 on the card before the bonus categories start earning 5% cash back. So basically, once your spending had surpassed $6,500 for the year, you could earn unlimited 5% cash back at supermarkets, pharmacies, and gas stations. All of which sell gift cards. Sounds like a recipe for abuse, doesn't it? And abuse is what this couple did. Here's their strategy as described in the court ruling. To generate as many rewards dollars as possible, petitioners used the 1005 card and the 1001 card, that was their last four digits of their card numbers, both American Express cards, to buy as many Visa gift cards as they could from local grocery stores and pharmacies. In addition to the values of the gift cards, petitioners were charged service fees for the gift cards of between 0.8% and 1.2% of the gift card's base values. They used the gift cards to purchase money orders and were charged service fees for the money orders of between 0.07% and 0.33% of the dollar amounts of the money orders. They deposited the money orders into their bank accounts. And that money would then be used to pay off their credit cards, but they were earning 5% in rewards in the process. Their costs were about 1.5% in those fees that were just described, so in the end they were pocketing 3.5% profit on every dollar they spent. The case states that all of the petitioner's charges of over $400 on their American Express cards in the years 2013 and 2014 were for Visa gift cards and various other types of prepaid cards and money orders. They spent $1.2 million on these things in 2013 and over $5 million in 2014. And through this method, they earned over $300,000 in extra income. $35,000 in 2013 and $276,000 in 2014. Now, of course, Amex closed their accounts. And to be honest, I'm surprised that they got away with it for two years. And now, Amex has brought in limits on supermarket categories on many of their cards. For example, on the Amex Gold card, four points per dollar on supermarkets is limited to $26,000 in spending per year. And on the Amex Blue Cash and Blue Cash Preferred, the more recent versions of the card that this couple were using, the 3% and 6% categories at supermarkets on those two cards are limited to $6,000 in spending per year. So they flipped it around. It's $6,000 at 5% and then after $6,000, it goes back down to 1%. Whereas before, it was 1% to $6,500 and then above that, unlimited 5%. As for the couple, they now owe the IRS probably up to $100,000 depending on income plus interest for their manufactured spend escapade. The judge ruled that the gift cards were cash equivalents, not products. And so the rebates from them were taxable. Now, don't get worried if you go and buy a gift card with your American Express card or any other credit card. Because if you actually use that gift card in the way that it is intended to pay for other products and stuff like that, it would then not be considered a cash equivalent. It's converted into a product and the rebate you got through your Amex membership rewards or whatever, any other rewards program would not be considered taxable. It's only if you find some way of using those gift cards or money orders to pay off your credit card, and then you do it on a very large scale that your credit card company and the IRS are going to notice. But I would say still the moral of this story is just don't do manufactured spending. There are so many other ways to earn points. For example, referrals on the Amex gold card. They're offering up to 35,000 points per referral just for referring your friends and family to the card. That's a great way to earn points. Then also on the Amex platinum right now, they have a 75,000 point signup bonus. Plus you get 10 points per dollar on gas on up to $15,000 worth of spending. So manufactured spend really isn't the only way to earn large amounts of points. And also there's the idea that credit card points, it's not a business in and of itself. In order to earn large amounts of money, it's a lot better idea to start an actual business. Now, don't get me wrong. I love credit card points. They've enabled me to go on vacations that I would never have been able to afford otherwise, but I've never treated it as a main sole business, all right? It's always a bonus on top of the money that I'm making. And I think it's very important to treat it like that. These things shouldn't be income. They are an extra reward to enhance your lifestyle on top of your income. If you have that mentality, I think you can't go wrong. And speaking of income, if you want to learn more about making money, why not go and subscribe to my new channel, The Business Shifu? I'm going to be putting a lot more of my personal finance, investing and business type videos on that channel. So do go and check it out. I'll put the link on screen in just a moment and in a pinned comment below. If you guys like the idea of the two cards I mentioned in this video, the Amex Gold and Amex Planet, both of which have great signup bonuses right now, feel free to click the link below as well. As always, subscribe if you're new, leave your comments below and we'll see you next time. Bye-bye.