EDITOR’S NOTE: I’m on an annual blogging vacation for the last two weeks of the year. To make sure you still have content, some of the smartest members of the community have stepped up with guest posts in my absence. Special thanks to Graham, the author of the TC Tailwind Blog, who candidly shares his story on the dark side of credit card churning for writing this post. I’ll see you on January 1!
tl;dr: If you have multiple players with different tax situations, being smart about who earns taxable referral or bank account bonuses could more than double your post-tax earnings. Or it could make no difference at all. Calculate the difference it would make for you, by punching in a fake 1099 to last year’s TurboTax file.
Credit card sign up bonuses and points from spend aren’t usually considered taxable, but referral bonuses, checking account promos, and plenty of other kinds of rewards are. This tax treatment means that if you’re a high earner, you could be paying up to half of the bank-assigned value of your points in taxes. For some pathologically high points valuations, this could even result in owing more in taxes than what you think your points are worth. These facts make it worth doing what you can to optimize the tax treatment of your points.
In investing, Asset Location is the concept of putting assets with poor tax treatment into tax advantaged accounts (eg. holding bonds in your 401k to avoid paying annual taxes on the dividends). In the churning world, those of us with multiple players can practice a similar concept, by locating our taxable earnings with the player with the most favourable tax situation.
How much of a difference can this location strategy make? Let’s run a few scenarios. In each scenario, we’ll assume that:
- We’re going for a $900 Chase checking bonus (while SideShowBob233 howls faintly in the distance).
- It is equally convenient in our churning plans for P1 or P2 to receive the bonus.
- There are no special tax situations, such as ample capital losses that one player or the other could use to balance out their earnings.
Here are a few scenarios:
- The Best:
- P1 is a very high earner in California and would be subject to a 37% Federal, 3.8% NIIT, and 12.3% State tax on the bonus, for a total of 53.1%.
- P2 has no income, can take the standard deduction, and will be subject to no state or federal tax.
- Results: P1 would pay $477.90 in taxes, keeping only $422.10 of the bonus. P2 would pay $0 in taxes, and keep the full bonus. Earning the bonus with the right player would more than double your earnings from $422.10 to $900.
- The OK:
- P1 and P2 live in Florida, and would be subject to only a 24% and 12% Federal tax respectively on the bonus.
- Results: P1 would pay $216 in taxes, keeping $684 of the bonus. P1 would pay $108 in taxes, keeping $792 of the bonus. Earning the bonus with the right player would moderately increase your bonus earnings by $108 from $684 to $792.
- The Wash:
- P1 and P2 are married and file their taxes jointly, meaning they share a tax rate.
- Results: It doesn’t matter who gets the bonus, it will increase their joint taxes.
Does taxable bonus location matter to you? Taxes are complicated, so it’s hard to know for sure. You might be able to eyeball the impact by looking at the above scenarios and seeing which looks closest to your situation. For an even more exact estimate, boot up last year’s TurboTax (or other tax software of your choice). Try punching in a fake 1099-INT with $900 in Box 1, for P1 and then for P2. That will tell you how much more each player would have paid in taxes last year, if they’d gotten this Chase bonus.
P.S. If you’re interested in more nitty-gritty financial optimization content like this, check out my blog. There’s a subscribe box at the bottom of every page, if you’re interested in seeing new content as it comes out. And if you think I’ve missed something, gotten something wrong, or should write future posts on a particular topic, please drop me a line.
– Graham
SideShowBob face-planing while howling in the distance.