What cash back means and how you earn it

A cash back credit card returns a small percentage of the money you spend back to you. When you use the card to buy something, the card issuer — the bank or company that issued the card — gives you a rebate. That rebate is the cash back. It typically ranges from 1% to 5% of what you spent, depending on the card and what you bought.

The card issuer pays this rebate from the fees merchants pay them. When you swipe a card at a store, the merchant pays the card issuer a processing fee. The card issuer uses part of that fee to pay cash back to cardholders. This is why the card issuer can afford to give money back — they are not losing money on the deal.

Cash back appears as a credit on your statement or gets deposited into a bank account you link to the card. Some cards let you choose: you can take the cash back as a statement credit (which reduces what you owe), or request it as a check or bank transfer. A few cards let you use cash back to buy things through their shopping portal instead.

Key Takeaways

  • Cash back is a percentage of your spending that the card issuer returns to you, funded by merchant fees rather than the card issuer's own money.
  • Different cards offer different rates for different categories — groceries, gas, restaurants — so the card that pays the most depends on where you spend the most.
  • You only earn cash back on purchases you actually make; you do not earn it on a balance you carry over from month to month.
  • If you carry a balance and pay interest, the interest charges will almost always exceed the cash back you earn, making the card a net loss.
  • Cash back is taxable income in the eyes of the IRS, though most cardholders receive a 1099 form only if they earn more than $600 in a year.

How cash back rates vary by card and spending category

Not all cash back is the same. Some cards offer a flat rate — say, 2% back on everything you buy. Others offer higher rates on specific categories and a lower rate on everything else. A grocery-focused card might pay 3% on groceries, 2% on gas, and 1% on everything else. A travel card might pay 3% on airfare and hotels, 2% on restaurants, and 1% on other purchases.

The card issuer sets these rates to encourage you to use their card for the kinds of purchases they want to incentivize. A grocery card issuer wants you buying groceries with their card instead of a competitor's. They pay a higher rate to make that happen.

Some cards have rotating categories that change each quarter — one quarter groceries earn 5%, the next quarter gas stations do. These cards usually require you to set up the category each quarter or the higher rate does not explore. Read the terms carefully, because forgetting to set up means you earn the lower default rate instead.

The difference between earning cash back and keeping it

Earning cash back and actually benefiting from it are two different things. If you carry a balance on the card — meaning you do not pay off the full statement balance each month — you pay interest. That interest is usually much larger than the cash back you earn.

Say you spend $1,000 a month and earn 2% cash back, which is $20. If you carry that $1,000 balance and the card charges 18% annual interest, you pay roughly $15 in interest that month alone. Over a year, the interest far exceeds the cash back. You are paying to earn the reward.

Cash back only makes financial sense if you pay off your full statement balance every month. If you cannot do that, the interest will cost you more than the cash back is worth. In that case, a card with a lower interest rate (if such a thing exists for your credit profile) or no card at all is the better choice.

Annual fees and whether they eat into your cash back

Some cash back cards charge an annual fee — $95, $150, or more. Before you sign up, do the math: will the cash back you earn in a year exceed the fee?

If you spend $10,000 a year and the card pays 2% cash back, you earn $200. If the annual fee is $95, you come out $105 ahead. But if the card pays 1% and the fee is $150, you earn $100 and lose $50 overall. The card issuer counts on many cardholders not doing this math and paying a fee for rewards they do not actually come out ahead on.

Cards with no annual fee usually offer lower cash back rates — often 1% flat or 1% to 2% in categories. These are a better fit if you do not spend enough to make a premium card's higher rewards worth the fee, or if you want to keep things straightforward.

How to actually use and redeem your cash back

Cash back sits in your account until you do something with it. The mechanics depend on your card. Some cards let you redeem cash back anytime, even $1 at a time. Others have a minimum — you must have at least $25 before you can cash out. A few cards only let you redeem once a year.

When you redeem, you choose how to receive it. Most commonly, you can take it as a statement credit (the card issuer subtracts it from what you owe), a check mailed to you, or a transfer to a linked bank account. Some cards offer a third option: you can use cash back to buy things through the card issuer's shopping portal, though this usually gives you less value than taking the cash itself.

If you do not redeem cash back, it does not expire on most cards — it stays in your account indefinitely. But if you close the card, you typically lose any unredeemed cash back. Before closing an account, check your balance and redeem what you have.

Why card issuers offer cash back and what it costs them

Card issuers offer cash back because it makes them money, not because they are being generous. When you use a credit card, the merchant pays the card issuer a fee — usually 2% to 3% of the transaction. The card issuer keeps part of that fee and uses part to pay cash back to you. They also make money from interest if you carry a balance, and from annual fees.

The card issuer is betting that the cash back will make you use their card more often and keep the account open longer. They are also betting that some cardholders will carry a balance and pay interest that far exceeds the cash back. From the issuer's perspective, cash back is a marketing cost that pays for itself.

This is why card issuers can afford to pay you back at all. They are not losing money on the deal. They are making money on merchant fees, interest, and annual fees — and using a small portion of that to attract and keep customers.

Tax reporting and whether you owe taxes on cash back

Cash back is technically taxable income. The IRS considers it a rebate on your purchase, not a gift, so it counts as income you have to report. However, most people do not actually report it because the IRS does not require card issuers to send a tax form unless you earn more than $600 in cash back in a calendar year.

If you earn $600 or more, the card issuer will send you a Form 1099-MISC in January. You will need to report that income on your tax return. If you earn less than $600, no form is sent and the IRS does not expect you to report it — though technically you could if you wanted to be thorough.

The practical reality is that most cardholders earning modest cash back amounts do not report it and the IRS does not pursue it. But if you earn a large amount — say, you run a business and put $100,000 a year on a 2% cash back card — you should report it and be prepared to pay tax on it.

Frequently Asked Questions

Can I earn cash back on a balance I already owe?

No. Cash back is earned only on new purchases you make with the card. If you carry a balance from a previous month, you do not earn cash back on that balance. You only earn cash back on the new charges you add to the card going forward.

What happens to my cash back if I close the card?

You lose any unredeemed cash back when you close the account. Before closing a card, log in and redeem whatever cash back balance you have. Once the account is closed, that money is gone.

Do I have to use the cash back to pay my bill, or can I take it as actual money?

Most cards let you choose. You can take it as a statement credit (which reduces your bill), request a check, or transfer it to a bank account. Some cards also let you use it to shop through their portal, though that usually gives you less value than taking the cash itself.

If I earn 5% cash back but the card charges 18% interest, am I coming out ahead?

Only if you pay off the full balance every month. If you carry a balance, the 18% interest you pay will far exceed the 5% cash back you earn. You would lose money overall. Cash back only works in your favor if you do not pay interest.

Does cash back count as income for government benefits?

It depends on the benefit program. Some programs count any income, including cash back, toward your may be able to access limit. Others do not count rebates. If you receive means-tested benefits, contact the program directly to ask whether cash back counts as income for your situation.