The pitch went out to eye doctors, McDonald’s Corp. MCD 0.61% franchisees and payroll companies: “Reduce your taxable income burden to Uncle Sam.”
In phone calls, emails and in-person meetings with thousands of business owners, American Express Co. AXP -1.52% salespeople laid out the strategy. Use AmEx to pay your employees and suppliers, they said. You’ll have to pay a fee, but you’ll come out ahead. That’s because you can earn rewards on the transaction that can be converted into untaxed cash, while also deducting the transaction fees for tax purposes.
The pitch helped AmEx bring in billions of dollars of transaction volume since at least 2018, according to people familiar with the matter and documents reviewed by The Wall Street Journal. But there was a problem: The strategy relied on a shaky interpretation of how tax law treats rewards points.
In July, a whistleblower filed a report with the Internal Revenue Service alleging that AmEx knowingly persuaded business owners to underreport their income and taxes.
This is “a big company encouraging tax wrongdoing,” said Gregory Lynam, co-founder of Lynam Knott, the law firm that filed the report on the whistleblower’s behalf. It “promotes a tax shelter that doesn’t work.”
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AmEx, through a spokesman, acknowledged that some members of its U.S. sales organization “failed to uphold our values and had positioned certain products inappropriately, specifically with respect to tax benefits.”
AmEx discovered the pitch through internal channels, the spokesman said, and has hired a law firm to investigate. “This misconduct should not have happened,” he said.
AmEx has terminated, disciplined or retrained some employees, and compensation plans have been adjusted. “We will take further action if appropriate,” the spokesman said.
The products associated with the pitch accounted for about one-half of 1% of AmEx’s total network volumes and less than one-quarter of 1% of its revenue globally from 2018 until the present, he said. The company, he said, this month discontinued wire services associated with the pitch.
Sales employees flagged concerns to senior sales staff, human resources and the company’s ethics portal after business owners and their accountants questioned the tax advice, the people familiar with the matter said. They pointed to IRS guidance that says rewards points accrued from business expenses that are converted to cash aren’t necessarily tax-free, contrary to the sales pitch.
Bruce Friedland, an IRS spokesman, said the agency can’t comment on any specific card issuer or their rewards programs.
The tax treatment of rewards points is “very fact intensive” for small-business owners, Mr. Friedland said. “We would encourage those with questions on the proper treatment to consult a tax professional.”
Current and former employees say the strategy grew out of AmEx’s efforts to increase transaction volume over its network. It costs money to send money. Pay with a card, and the business on the receiving end bears the cost. Many businesses refuse to accept cards because they don’t want to pay the fees.
The AmEx tax pitch revolved around persuading the payer to cover the transaction cost, regardless of payment method. Several of AmEx’s payment products, including wire services and cards, were involved.
Salespeople and their supervisors earn commissions tied to customer-spending volume. Executive bonuses are also influenced by the success of sales teams. Sales targets, say people familiar with the matter, have increased substantially over the past four years, in some cases by more than 100%.
Pressure to hit aggressive sales goals led employees to misrepresent the costs and benefits of AmEx business cards to potential customers, the Journal previously reported. At the time, an AmEx spokesman said the company found a very small number of cases “inconsistent with our sales policies.”
The Justice Department’s civil fraud and criminal divisions are investigating AmEx’s business-card sales practices, as are the Office of the Comptroller of the Currency and the inspectors general offices of the Treasury Department, Federal Deposit Insurance Corp. and Federal Reserve. The company has said it is cooperating with the probes.
Salespeople focused on business customers whose vendors didn’t accept AmEx cards. Businesses that used AmEx’s wire services to pay vendors would have to pay fees of between about 1.77% and 3.5%, according to AmEx training and sales documents and people familiar with the matter.
Business owners were told that they could deduct those fees from their businesses’ taxable income as ordinary expenses, the people said. The strategy had another benefit, business owners were told: They could earn reward points and could convert them into untaxed cash using the AmEx Platinum Charles Schwab card, the people said.
‘If people are doing this as a way of charging their business expenses, taking the deduction for the full invoice price and then pocketing on the personal side for the cash rewards, I think they’re violating the guidance from the IRS.’
— Christopher Hesse, accountant
Here’s how the tax math was described in an AmEx document viewed by the Journal: A business owner would use AmEx’s wire services to send $10 million for a 1.77% fee—or $177,000. Assuming the business owner would pay a 42% combined federal and state marginal income-tax rate, the owner would deduct the fee for a $74,340 reduction in taxes, lowering the transaction’s net cost to $102,660.
The business owner would also earn one point per dollar spent, or 10 million points. The owner could then transfer the points to a personal AmEx Platinum Charles Schwab card at 1.25 cents per point, generating a cash reward of $125,000. Subtract the net transaction cost of $102,660 for a gain of $22,340.
It was a “much greater value than cost with an INDUSTRY EXCLUSIVE offer only provided through AMEX,” the document said.
But the strategy works only if the business deduction is allowed in full and if the income from the rewards points isn’t considered taxable. Otherwise, the cost of the transaction would exceed the tax benefits.
Rewards points generally aren’t considered income for individuals who generate them when they make personal purchases. Instead, they are viewed as a discount on purchases. It is less clear-cut when there is a separation between the entity earning the reward—the business—and the individual receiving the awards.
AmEx in Focus
Articles about the company’s sales practices, as selected by WSJ editors
AmEx Staff Misled Small-Business Owners to Boost Card Sign-Ups (March 1, 2020)
Federal Investigators Probing AmEx Card Sales Practices (Jan. 7, 2021)
American Express Acknowledges DOJ Review of Card Sales (Feb. 12, 2021)
In guidance released in 2002, the IRS said that it wouldn’t challenge taxpayers who redeem miles earned from business travel for personal use but said that protection didn’t apply to cash conversions. The IRS has pursued taxpayers through audits in special cases involving rewards, and cash bonuses for opening bank accounts are now considered taxable income.
“If people are doing this as a way of charging their business expenses, taking the deduction for the full invoice price and then pocketing on the personal side for the cash rewards, I think they’re violating the guidance from the IRS,” said Christopher Hesse, an accountant at CliftonLarsonAllen who reviewed the AmEx strategy at the Journal’s request.
“Schwab does not condone this kind of sales pitch, and we appreciate that American Express is addressing it with the employees involved,” a Charles Schwab Corp. spokesman said.
The tax pitch gained steam after AmEx cracked down on misleading sales tactics in its foreign-exchange business, causing sales in the unit to fall. The pandemic added even more urgency to the sales push, people familiar with the matter said. Travel rewards had fallen out of favor, and cash-back options were in.
Senior sales employees told salespeople to dial up “points junkies” who might be receptive to the pitch, according to people familiar with the matter. Salespeople on recorded lines teamed up with colleagues whose communications weren’t as closely monitored. Senior sales employees encouraged them to keep customers’ accountants out of the conversations.
“No staff, CPAs or Tax Attorney’s,” a sales director wrote in an email to salespeople who were trying to sign up a prospective client.
Brandon Pope last year fielded the tax pitch on behalf of a wealthy entrepreneur whose finances he manages. A skeptical Mr. Pope said he asked to speak with an AmEx lawyer. His request, he said, was declined.
“No AmEx attorney nor IRS attorney will take a hard line on this since it’s such a grey area and always has been,” the AmEx salesperson wrote in an email to Mr. Pope.
Mr. Pope said that he and his client stopped talking to AmEx.
Sales teams were told to discontinue the tax pitch during an early 2020 company call, according to people familiar with the matter. Vice presidents and directors on the sales teams later told salespeople they could continue making the pitch as long as they didn’t leave documentation with customers, according to people familiar with the matter.
Tim Bianchi’s Iowa payroll and human-resources company started accepting AmEx cards in 2019 after two AmEx divisions walked him through a strategy that would allow him to unload card fees onto his clients.
AmEx cardholders were willing to incur the fee, Mr. Bianchi said he was told, because of the tax benefits. Mr. Bianchi’s business, Avail Professional Services, invoiced clients for the card fees until this April, when, he said, AmEx without explanation shut off Avail’s ability to accept payments.
McDonald’s franchisees were an especially attractive target for the tax pitch because the Martin-Brower Co., a major distributor of supplies such as burger patties, utensils and McDonald’s-branded cups, doesn’t accept credit cards.
Here’s how it works: AmEx issues a card to the franchisee that can be used only for Martin-Brower purchases, according to people involved with selling the service. AmEx pays Martin-Brower on the franchisee’s behalf and charges the franchisee’s card account for the amount owed, plus a transaction fee of about 1.7%. The franchisee has about 30 days to pay AmEx and earns points on the transaction.
At least 300 McDonald’s franchise owners with more than 2,000 store locations are signed up for the service, charging $3 billion to $5 billion each year, according to people familiar with the matter.
“Most owners are levering this program as a key strategy to reducing their taxable income, thus paying less taxes to the government,” an AmEx salesperson said in an emailed client pitch reviewed by the Journal.
An AmEx spokesman said the company will stop giving out rewards through the program. The company is also notifying franchisees that fees will drop to 0.6%. Both changes are set to kick in on Monday.
Jim Lewis didn’t bite when an AmEx salesperson called with the pitch a few years ago. Mr. Lewis, whose 17 locations with McDonald’s did around $70 million in sales a year at their peak, didn’t consider the potential benefit worth the risk.
“It was worrisome,” said Mr. Lewis, who retired in 2019 after 33 years. “It just didn’t seem worth risking my millions of dollars in business to save 10 or 20 grand.”
