A tax-planning adage states, “Pigs get fed; hogs get slaughtered.” In pushing a “dodgy tax break” to business customers, AmEx taught itself and them a lesson they should have already known.
AmEx’s Tax Alchemy
AmEx wanted to boost commission fees from business customers. So, it suggested to owners of closely held businesses that they make payroll and other large payments using AmEx wire-transfer services.
Here’s how AmEx’s pitch went. At current rates, a $10,000,000 payment made via AmEx wire transfer would generate $177,000 in AmEx fees. Assume the business owners paid income tax (federal+state) at a 42% marginal rate. In such case, if the owner fully deducted the fees, their after-tax cost would fall to $102,660 ($177,000 x (100%-42%)).
Now for the alchemy. AmEx sales people told customers that payments made via AmEx wire transfer would earn one rewards point per dollar sent by wire. Rewards points could be transferred to a personal AmEx Platinum Charles Schwab card in the owner’s name. This card would let the owner-cardholder redeem his or her points at 1.25 cents per point. So, 10,000,000 points would convert into a non-taxable cash payment to the owner of $125,000.
When the smoke cleared, using this scheme, the owner would net $22,340 (the $125,000 non-taxable payment, less the $102,660 after-tax cost of AmEx’s fees).
The loser in this shell game was the federal Treasury.
Alas for AmEx and the customers, this scheme depends upon customers being able to fully deduct the $177,000 while paying no taxes on the $125,000 redemption of points.
While federal tax authorities generally overlook rewards-program redemptions made in kind (such as airline-frequent-flyer miles redeemed for air-travel tickets), authorities take a different view of cash-back redemptions.
AmEx’s arrangement didn’t pass the smell test. If the business and the business owner are separate taxpayers, transferring the rewards points from business to owner will look at the least like taxable compensation or dividends of $125,000.
If, on the other hand, the business and the business owner are treated as one taxpayer, the $177,000 payment and $125,000 cash redemption will form part of an overall plan and be netted out. This results in a net tax-deductible commission paid to AmEx of $52,000 ($177,000-$125,000). That matches the net revenues AmEx books, with no net cost to the federal Treasury.
Echoes Of The Wells Fargo Scandal
Readers may recall the scandal at Wells Fargo Bank, in which over 5,000 employees opened over 3.5 million accounts in the names of hundreds of thousands of customers.
Like former Wells Fargo CEO John Stumpf, AmEx leadership has downplayed the severity of the scandal by focusing on the limited impact of misbehavior in relation to the company’s overall bottom line. Errant employees, AmEx tells us, have been terminated, disciplined, or retrained.
But the nub of the Wells Fargo scandal was not about front-line employees. Even banker-nemesis Senator Elizabeth Warren painted these employees as $14/hour victims, pushed by their corporate taskmasters past the breaking point.
The issue at Wells Fargo was the senior executives who failed to put in place proper controls and enabled a deeply corrupt culture.
Similarly, the issue at AmEx is the judgment and probity of senior executives, as well as the culture they created. These executives reportedly told sales staff to avoid speaking with prospects’ tax advisors, or providing documents on the scheme. Staffers also reportedly colluded to avoid having their pitch calls recorded by AmEx compliance-monitoring equipment.
The Oscar-winning movie The Sting opens with two, small-town, Depression-era grifters accidentally conning the bagman of a New York gangster kingpin. In response, the kingpin sends out his hitmen.
Wells Fargo only cheated several-hundred-thousand retail customers. AmEx, on the other hand, has tried to rip off the federal government. Expect Uncle Sam to send out the Internal Revenue Service and Department of Justice.
This could get bloody.