Recently, Citibank started issuing Form 1099s to customers who opened accounts at the bank and received airline miles as a prize. The bank valued the miles at 2.5 cents per mile. According to Citibank, the airline miles are considered a prize and, therefore, taxable under Internal Revenue Code Section 74.
Citibank claims that miles earned by using their credit cards is different and not taxable. The bank considers airline miles like a discount or rebate and pricing discounts are clearly not taxable. The discount in price or rebate is simply a reduction in the price paid by the consumer.
IRS is processing Citibank's filing and trying to come up with a straight forward answer. Unfortunately, a straight forward answer is not associated with the IRS.