IRS Wants to Tax Rapid Rewards

IRS Wants to Tax Rapid Rewards

Few things anger the federal government more than success. Love ’em or hate ’em, Martha Stewart, Microsoft, and now, Southwest Airlines, all can sing a new version of the old saw: Build a better mousetrap and the world will beat a path to your door … and the feds will be right behind.

Recently, Southwest drew the ire of the IRS, which declined to allow deductions for the cost of the Rapid Rewards program from 1992 through 1995, and demanded $357,135 in back taxes.

In a notice of deficiency issued Dec. 31, the agency said that the $1.77 million cost of running the Rapid Rewards program in those three years could not be deducted.

The IRS disallowed the deduction because Southwest’s accounting methods failed to “satisfy the ‘all-events’ test” required by the Internal Revenue Code.

Southwest, which estimates the cost of a reward ticket at about $10 for the period in question, debits that amount on its passenger revenue account and credits its air traffic liability account when the ticket is issued. Once the flight is taken, the process is reversed.

As a result, the company’s income (at least in the eyes of the IRS) increased to $57.2 million in 1992, $124.6 million in 1993, and $190.2 million in 1994.
The company filed a petition in U.S. Tax Court in April asking that the order be overturned.

A spokesperson for the airline declined to comment, as company policy prohibits the discussion of pending litigation.

The total back tax bill represents about .1 percent of Southwest’s income for that three -year period.

At the same time the government is demanding this less than sizeable amount, it has, over the past two years, doled out approximately $5 billion in cash to the airline industry. Southwest, though it has become the fourth largest airline in the country, received about $300 million of that aid — the seventh-smallest pay-out.

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