Taxes on cash back credit card rewards

Question

Me and a friend discussed a potential loop hole in cash back credit cards. I want to write up a research article to pursue this further. Lets says I have a credit card with 10% cash back rewards. I also open up an online credit card processor that charges 3% on all transactions. If I charge myself a $100 to get a cup of water, would I:

• earn $7 (7%) tax-free dollars on each transaction? - https://www.investopedia.com/ask/answers/110614/are-credit-card-rewards-considered-taxable-income-irs.asp
• have $3 (3%) loss that can be deducted from my income tax?
• if all transactions occur in a sales tax-free state like Delaware, no other fees are involved?
• is it legal to buy and sell from and to yourself?

Answer 1

Among the issues

• You can't realistically get a credit card that would give you 10% back.
• You can only deduct losses to the extent that you are running a business. That requires that you show an intention of turning the profit. Unless you were successfully selling $100 cups of water to a lot of other people, your losses would almost certainly be disallowed.
• Any cash-back card is going to have terms that disallow this sort of sham sales. And they'll notice pretty quick that 100% of sales are being made to a single customer. At best, they'll close your account. More likely, they'll try to claw back any rewards you've received.

Answer 2

Your $10 cashback is tax free.

However, your water-selling business made a profit of $95 = $100 - $1.85 (for the glass) - $.15 (for the water) - $3 (for the credit card processing fee).

You'll get to pay federal income tax on that $95 net income, which will more than erase the cashback.

Plus the card issuer has certainly written the cashback terms and conditions to exclude self-dealing. So now you have no cashback, $3 in credit card processing fees, and taxes on $95 net business income.

Answer 3

Sure, if you could get a credit card that gives a 10% cash back reward, while you have to pay about 3% in credit card fees every time you sell something, you could make a bundle by buying things from yourself.

The catch to that is that I don't know where you think you're going to get a credit card with 10% cash back reward. More common is 1% or maybe 2%. For the very obvious reason that if the bank was charging 3% and paying out 10% on every dollar, they would quickly go broke. Whether you are buying things from yourself or someone else, the bank would go broke.

A bank might offer a money-losing deal as a promotion to drum up new customers. Maybe possibly you could find such a deal where they hadn't thought out the restrictions well enough, and you could take advantage and make a killing before they caught on and cancelled the promotion.

So sure, you could fantasize about, What if some business offered to give me money to use their services instead of charging me? In real life, that's not likely to happen.