The Internal Revenue Service is studying whether to tax as income the free tickets that members of airlines' frequent-flyer programs earn for piling up miles.
The programs, started by American Airlines to attract and hold high-volume business travelers, are operated by every major domestic carrier. American, Delta, Eastern and United -- four of the nation's largest airlines -- claim a total of more than 6 million members in their clubs. Many people join more than one airline's program.
IRS spokesman Ellen Murphy said no decision has been made on whether to draft a regulation or leave the potentially touchy subject alone. The IRS is interested because business travel is usually paid by companies, while the free-flight benefits accrue to the individual and thus appear, in most cases, to be personal income.
Frequent-flyer programs may be addressed in pending regulations on the taxation of employe fringe benefits, but that has not been decided, Murphy said. The draft of the regulations does not mention frequent-flyer programs, she said.
IRS officials think that, technically, existing law requires that frequent-flyer bonuses be taxed. But without regulations on how to value the flights and who is responsible for reporting them, the IRS would find it difficult to collect the taxes.
Airlines hold contrasting views of the programs, depending on their size. "We think it's the best marketing tool we've had in years against the upstarts or low-cost carriers who tend to pick off our best routes," Eastern Air Lines executive Don Metcalfe said.
Lamar Muse, chairman of Muse Air, told Congress recently that his airline operates nonstop jet flights between Austin and Los Angeles for a round-trip fare of $198. American, which claims to have the biggest frequent-flyer program, offers one-stop service between the cities with a normal round-trip coach fare of $646, although limited discounts are available.
Despite the price difference, Muse said, he can't fill his plane. "These programs have served to make mileage junkies out of otherwise normally intelligent businessmen at the incalculable cost of hundreds of millions of dollars to the federal government," he said.
A typical frequent-flyer program permits a member to upgrade his coach ticket to first class once he has flown 10,000 miles on the airline; offers a 25 percent discount on a round-trip ticket anywhere the airline flies after 20,000 miles; provides a 50 percent discount after 25,000 miles, and gives a free ticket after 30,000 miles and two tickets after 50,000 miles.
Many airlines have worked out deals to grant extra mileage if a traveler uses a specific hotel chain or rental-car company.
Randall Malin, USAir's senior vice president for marketing, calls frequent flyer "the most successful brand-preference marketing program put out there."
"No one is going to wait an extra hour to fly his favorite airline if the flight is only one hour and 20 minutes long. However, frequent flyer has built in an offset to the disadvantage," Malin said.
Washington-based USAir was the last major airline to start a frequent-flyer program. It did so Jan. 14 and has more than 200,000 members. It costs nothing to sign up for any of the programs, and all airline officials interviewed agreed that many passengers on their rolls do not fly frequently.
One reason USAir waited so long, Malin said, was because of concern that the IRS would impose stiff reporting procedures on airlines. That does not appear to be the case, he said. The airlines view frequent-flyer programs as volume discounts, which normally are not taxable.
If there is a reporting requirement, Malin and other industry sources said, it probably will be placed on the business traveler's employer.
One huge travel agency, Ask Mr. Foster, has developed a computer program to track its employes' flights, by airline, and in effect signal when an employe becomes eligible for an airline bonus so the bonus can be collected and returned to the corporation. Leigh Kimball, a vice president at Ask Mr. Foster, said, "Most corporations let their employes keep the bonuses."
Based on recent behavior, Congress appears unlikely to put up with any IRS regulation that would inconvenience many people. Last week, the House and Senate voted overwhelmingly to repeal congressionally mandated IRS rules requiring that companies detail business use of autos that employes also use for personal reasons.
Experts say bonuses to individuals are taxable because they are not excluded by law, as are such employer-paid benefits as health insurance premiums or pension contributions. The 1984 tax law cracked down on certain fringe benefits but did not mention frequent-flyer bonuses.
Tax attorney Jonathan Barry Forman, writing in the private publication Tax Notes, said, "Since the employer paid for the tickets, the employer owns the resulting free pass, and if he allows the employe to keep it, the free pass is a taxable fringe benefit just as if the employer had gone out and bought 10 airline tickets and given one to the employe."
Former IRS commissioner Sheldon Cohen said there is no question that frequent-flyer bonuses are taxable income and that he thinks the IRS would have little difficulty assigning a value to them.