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Backstory:
Over the past two years, I've been in an ongoing battle with a phone provider over a promotion they failed to honor in a reasonable amount of time. I had posted a few questions on the Law Stack Exchange (Here and Here) to explain the situation and see what legal insights I could gain. Well, I went through arbitration and was awarded, via check (USD), the promotional credits and interest. The original promotion would have been for account credits and, like most places, the company made it very clear that they had no cash value.

Onwards:
In various conversations with coworkers and friends about this, we hit a situation where taxes came to mind. I started to wonder how my tax situation would have changed depending on the two methods that could have paid out (credits vs cash). I presume the award I received from arbitration ($950+ USD) is taxable and will require something like a 1099-MISC form, but I'm not sure if/how taxes would have taken place for credits.

Questions:

  • If the business would have honored the 900 account credits originally (these credits act like a 1-to-$1 ratio in terms of paying a bill), would those have been taxable?
  • If so, how would one even go about deciding the correct value that a credit would be worth?

I'd hope that money locked into account credits to pay a phone bill is of lesser value than money in hand. I'm concerned that this may be a bit more gray than I'm hoping. I know Bitcoin is taxed like property, but I don't know if that carries over to credits because these credits cannot be cashed out via any first or third-party services.

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    Discounts/rebates/refunds aren't taxed, they just negate some/part of a prior/future transaction. – Hart CO Nov 15 '17 at 23:24
  • I've never thought of account credits as something that sits well in those categories, but I'm not super informed. I suppose the closest they could be is a type of refund, but it would still feel strange to categorize them in that way. Very interesting to consider though~! – Xrylite Nov 16 '17 at 23:30
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    For US, lawsuit award or settlement received is taxable, whether or not 1099 is issued, unless it is compensation for physical injury or sickness; see pub 525 p29 (at 5 b) – dave_thompson_085 Nov 17 '17 at 18:32
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It turns out that there are a few terms and factors involved that help to determine whether account credits provided by a business are taxable.

To begin, there are two types of virtual currencies: convertible (open) and non-convertible (closed). The key difference between these two is whether or not they can be directly and legally converted to fiat. This is made especially clear when you see disclaimers like, "Not redeemable for cash." on things like vouchers. Since the currency provider has restricted the ability to exchange for fiat, these would be considered a closed virtual currency.

Closed virtual currencies have far more restrictions than open virtual currencies do. Their use tends to be exclusively within the business (through receiving goods or services); the business controls the creation and distribution; the business can choose to stop supporting them; and the business determines how they are valued within the business. The emphasis is essential as closed virtual currencies are not taxable and are essentially valueless to the IRS.

How to determine what type of virtual currency you have is also made clear in Internal Revenue Bulletin: 2014-16 under section 2 of "IRS Virtual Currency Guidance":

IRS Virtual Currency Guidance

The Internal Revenue Service (IRS) is aware that “virtual currency” may be used to pay for goods or services, or held for investment. Virtual currency is a digital representation of value that functions as a medium of exchange, a unit of account, and/or a store of value. In some environments, it operates like “real” currency — i.e., the coin and paper money of the United States or of any other country that is designated as legal tender, circulates, and is customarily used and accepted as a medium of exchange in the country of issuance—but it does not have legal tender status in any jurisdiction.

Virtual currency that has an equivalent value in real currency, or that acts as a substitute for real currency, is referred to as “convertible” virtual currency. Bitcoin is one example of a convertible virtual currency. Bitcoin can be digitally traded between users and can be purchased for, or exchanged into, U.S. dollars, Euros, and other real or virtual currencies. For a more comprehensive description of convertible virtual currencies to date, see Financial Crimes Enforcement Network (FinCEN) Guidance on the Application of FinCEN’s Regulations to Persons Administering, Exchanging, or Using Virtual Currencies (FIN-2013-G001, March 18, 2013).

IRS Announcement 2002-18 presented some clarity to frequent flier miles as those too are considered a closed virtual currency since they can be redeemed for goods or services, but never for fiat.

IRS Announcement 2002-18

Most major airlines offer frequent flyer programs under which passengers accumulate miles for each flight. Individuals may also earn frequent flyer miles or other promotional benefits, for example, through rental cars or hotels. These promotional benefits may generally be exchanged for upgraded seating, free travel, discounted travel, travel-related services, or other services or benefits.

Questions have been raised concerning the taxability of frequent flyer miles or other promotional items that are received as the result of business travel and used for personal purposes. There are numerous technical and administrative issues relating to these benefits on which no official guidance has been provided, including issues relating to the timing and valuation of income inclusions and the basis for identifying personal use benefits attributable to business (or official) expenditures versus those attributable to personal expenditures. Because of these unresolved issues, the IRS has not pursued a tax enforcement program with respect to promotional benefits such as frequent flyer miles.

Consistent with prior practice, the IRS will not assert that any taxpayer has understated his federal tax liability by reason of the receipt or personal use of frequent flyer miles or other in-kind promotional benefits attributable to the taxpayer’s business or official travel. Any future guidance on the taxability of these benefits will be applied prospectively.

This relief does not apply to travel or other promotional benefits that are converted to cash, to compensation that is paid in the form of travel or other promotional benefits, or in other circumstances where these benefits are used for tax avoidance purposes.

Conclusion

Since the promotional account credits that were offered were a closed virtual currency due to their inability to be traded for fiat, the federal government does not deem them taxable and they can be seen as completely valueless. Even though the business may try and argue that they are used to "pay" for a bill or services, these credits are seen nothing more as a nontaxable rebate to the IRS.

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