How Do Cash-Back Credit Cards Work?

••• Images

Whether you're booking a flight or buying groceries, swiping your credit card is an easy and convenient way to pay. Signing up for a rewards credit card can be a great way to earn bonuses for your purchases. Some rewards cards give you points while others give you cash back. If you regularly pay with plastic, a cash-back credit card can help you save more on the things you buy the most.

Earning Cash Back

Every cash-back card has its own unique rewards structure, but they generally work the same way. When you use your card, you earn a percentage of your purchases back as a cash bonus. Depending on the card, you may earn a flat percentage on everything you buy or you may get more cash back on certain purchases, such as airfare or gas. Some cards may also offer cash-back bonuses to new members when they make their first purchase or spend a certain amount. You may be allowed to earn unlimited cash back or your card issuer may cap rewards once you reach a certain limit.

Redeeming Cash Back

Depending on your card issuer, you may have several options for redeeming your cash back. For example, you may be able to request a paper check or have your cash-back rewards automatically deposited to your bank account. Your card issuer may also give you the option of applying your rewards to your balance as a statement credit or using your cash back to make a donation to a participating charity. Some credit card companies also allow card members to convert their cash back to merchandise and gift cards from selected retailers. You may be required to earn a certain amount of cash back before you can begin redeeming your rewards.

Choosing a Card

When you're comparing cash-back cards, it's important to look for a card that matches your spending habits. Some cash-back cards are geared toward the everyday spender while others are designed for frequent travelers. You need to look for the card that lets you earn the most cash back in the categories where you spend the most money. In addition to the cash-back reward structure, you should also take a look at the interest and fees. The amount of cash back you're earning can be canceled out if you're paying a lot of money in interest each month or a high annual fee.

Tax Implications

Technically, cash-back rewards are not considered taxable income because you have to perform a financial transaction in order to earn them. When you use a cash-back card, you're effectively earning a rebate on the money you're spending, which has already been taxed. If, however, you use a cash-back card to purchase something of significant value and later sell it, you may have to reduce your tax basis by the amount of the cash back you received. If you receive other benefits, such as payment protection or insurance through the card, these may be considered taxable income.