By Richard Rubin
Konstantin Anikeev, an experimental physicist, assembled everything he needed for an inquiry far outside his field.
His materials included American Express cards, the government's view that credit-card rewards aren't income, and his own willingness to spend time buying gift cards and money orders. He pulled the concept from personal-finance websites: Exploit the difference between unlimited 5% rewards and lower fees on gift cards and money orders.
"If one has a theory, one can test it experimentally. Some are easier to test," Mr. Anikeev said. "Others require a Large Hadron Collider or something like that. But this one was a bit more accessible."
It (mostly) worked.
Mr. Anikeev's financial-optimization plan in 2013 and 2014 -- including $6.4 million in credit-card charges -- led to an Internal Revenue Service audit and a finding that he and his wife had more than $310,000 in income that should have been taxed.
Judge Joseph Goeke's decision last month largely affirmed longstanding Internal Revenue Service practice, which says credit-card rewards are usually nontaxable rebates. In other words, buying a pair of shoes for $100 and getting a 5% reward is really a $95 purchase, not $5 of income. But the judge also offered the IRS avenues for tougher enforcement.
Mr. Anikeev's interest in personal finance started when he was a graduate student with plenty of time but little money. The Connecticut resident drew on ideas from personal-finance websites, he testified at his 2019 trial.
In 2009, he, like many others, used a rewards credit card to buy $1 coins from the U.S. Mint, profiting from the lack of shipping charges on them.
By 2013, he found the strategy that would land him in tax court.
His American Express card offered unlimited 5% rewards at grocery stores and pharmacies after he had spent $6,500. So Mr. Anikeev used his AmEx card to buy prepaid Visa gift cards at grocery stores, routinely stopping during his commute and purchasing the maximum allowed per day at a store. He often used the gift cards to buy money orders, then used the money orders to make deposits in his bank account, then used that money to pay his credit-card bill.
In a $500 transaction, the 5% rewards would yield $25 -- more than enough to cover gift-card fees of about $5 and the $1 fee on the money order.
The millions of dollars of those transactions tripped the sensors at the Treasury Department's Financial Crimes Enforcement Network, which investigates money laundering, an IRS lawyer said during the trial. That agency kicked the case to the IRS, which said he owed back taxes. Mr. Anikeev took the government to court, bringing a tub of gift cards to his trial to demonstrate what he did.
"They sort of picked the fight with the wrong person," said his lawyer, Jeffrey Sklarz. "They should have picked someone who was a hot mess."
Judge Goeke issued a split ruling. Rewards earned on purchases of Visa gift cards aren't taxable, he ruled, because the cards are products; most but not all of Mr. Anikeev's transactions happened that way. Rewards earned on purchases of money orders or reloading debit cards are taxable, the judge determined. The IRS already says rewards can be taxable if they are earned without spending, such as a bonus for opening a bank account.
The two sides still must calculate what additional taxes Mr. Anikeev might owe. Andrew Johnson, an American Express spokesman, declined to comment on Mr. Anikeev's case. He said the company uses a "combination of strategies" to police the rules of rewards programs that don't allow purchases of cash equivalents. The IRS doesn't comment on active litigation.
Mr. Anikeev said he was somewhat disappointed. He said the judge's distinctions ignore that the IRS classifies money-order businesses as services and that money orders are items, and thus any rewards from purchasing them shouldn't be taxable.
Judge Goeke raised an alternate way for the IRS to attack future transactions like Mr. Anikeev's.
Perhaps, he wrote, if gift cards are property, the rewards reduce a person's cost basis in that property. Following that logic, exchanging gift cards for money orders would be selling property for a gain. The judge urged the IRS to consider regulations or public statements to offer clearer rules in case people are confused.
"How do you know when you cross the line?" said Robert Tobey, a partner at the Grassi accounting firm in New York.
The case highlights a flaw in the IRS approach to credit-card rewards, said Stephanie Hoffer, a tax-law professor at the McKinney School of Law at Indiana University.
Treating them like rebates makes sense for purchases of products, she said. But in Mr. Anikeev's case, there is no purchase of goods or services, just a circular money flow.
"I was really shocked by the outcome of the case. To me, this seems clearly to be income," Ms. Hoffer said. "At the end of the day, does this taxpayer have an accession to wealth? The answer is clearly yes."
Ordinary credit-card rewards users need not fear that they are earning taxable income. Even so, the case is a warning that activity far outside the norm might catch the government's eye, Mr. Tobey said.
Mr. Anikeev said he isn't doing anything like what he did in 2013 and 2014, though he is still just as interested in personal finance.
"He's a very mathematical, brilliant person," said his lawyer, Mr. Sklarz. "And this was just something he thought was fun."
Write to Richard Rubin at firstname.lastname@example.org
Corrections & Amplifications
This item was corrected on March 9, 2021 to show that Judge Goeke's first name is Joseph, not Robert.
(END) Dow Jones Newswires
March 07, 2021 09:14 ET (14:14 GMT)Copyright (c) 2021 Dow Jones & Company, Inc.