Who Actually Pays for Your Credit Card Rewards

The merchant pays for your rewards, not the card issuer

When you earn cash back or points on a purchase, the money comes from the merchant — the store, restaurant, or website where you bought something. The merchant pays a fee to the card network (Visa, Mastercard, American Express) every time you swipe or tap your card. That fee is called the interchange fee, and it's a percentage of what you spent, usually between 1.5% and 3%. The card issuer — your bank or credit card company — takes a cut of that interchange fee, and uses part of their cut to fund the rewards you see in your account.

This means the rewards program doesn't cost you anything directly. You're not paying an extra charge at checkout. But the merchant's cost of doing business goes up because of that interchange fee, and some merchants pass that cost along to all customers through slightly higher prices — whether those customers use a rewards card or not.

Key Takeaways

• Merchants pay interchange fees to card networks every time you use a credit card, and card issuers use part of that fee to fund your rewards.
• You don't pay a separate charge for rewards at the register, but merchants may raise prices slightly to cover their card-processing costs.
• Premium cards with higher rewards rates have higher annual fees because the issuer needs more revenue to cover bigger payouts.
• Debit cards and cash purchases don't trigger interchange fees, which is why some merchants prefer them and may offer discounts for paying that way.
• The rewards you earn are taxable income in the eyes of the IRS if they exceed $600 in a calendar year from a single issuer.

How interchange fees fund your rewards

Here's the chain: You buy a $100 item with a credit card. The merchant's bank pays the card network an interchange fee — let's say 2%, which is $2. That $2 goes to the card network first. The network keeps a small portion and passes the rest to your card issuer. Your issuer might receive $1.80 of that $2. From that $1.80, your issuer covers the cost of running the rewards program, paying customer service, fraud prevention, and their own profit. If your card offers 2% cash back, you'd earn $2 on that purchase, which comes from the issuer's share of the interchange fee.

The issuer is betting that the rewards they pay out will keep you using the card and carrying a balance, which generates interest income. On cards where you pay interest, the issuer makes money both from interchange and from the interest you owe. On cards where you pay off the balance every month, the issuer relies almost entirely on interchange to cover rewards and operating costs.

Why premium cards have annual fees

A card that offers 3% cash back or $300 in annual travel credits costs the issuer more to run than a basic card offering 1% back. The issuer can't cover those higher rewards from interchange fees alone — the math doesn't work. That's why premium cards charge annual fees ranging from $95 to $550. The annual fee gives the issuer enough revenue to pay out the bigger rewards without losing money on the program.

When you pay that annual fee, you're essentially paying the issuer directly for the rewards they're giving you. The interchange fees still flow in, but they're not enough by themselves. This is why premium cards only make sense if you spend enough to earn rewards that exceed the annual fee. A card with a $95 annual fee and 2% cash back needs you to spend at least $4,750 per year just to break even.

What merchants actually pay in card fees

Interchange fees vary by card type and merchant category. A grocery store might pay 1.5% to 2% per transaction, while a gas station or restaurant might pay 2% to 2.5%. American Express cards often carry higher interchange fees than Visa or Mastercard, which is one reason some small merchants don't accept Amex. A merchant processing $1 million in credit card sales per year could pay $15,000 to $30,000 in total card fees, depending on their mix of card types and customer behavior.

Merchants have no control over interchange rates — those are set by the card networks. What merchants can control is whether they accept credit cards at all, and some small businesses choose not to because the fees eat into their profit margin. Others accept cards but offer a discount for cash or debit purchases, passing the savings from lower fees directly to customers who pay that way.

How rewards affect prices you pay

Economists debate how much of the interchange fee gets passed to customers through higher prices. Some research suggests merchants raise prices by 0.5% to 1% to cover card fees, while other studies find little evidence of direct price increases. The reality is that pricing is complex — merchants consider labor costs, rent, inventory, and competition, not just card fees. A store in a competitive market might absorb card fees rather than raise prices, while a store with less competition might pass more of the cost along.

What's clear is that customers who pay with cash or debit cards are subsidizing customers who use rewards cards. The cash customer pays the same price as the rewards customer, but the merchant paid less to process the cash payment. Some merchants try to correct this by offering cash discounts, though federal law prohibits them from charging a credit card surcharge (with limited exceptions for American Express in some states).

Tax reporting for rewards over $600

The IRS treats credit card rewards as taxable income if they exceed $600 in a calendar year from a single issuer. Starting in 2024, card issuers are required to report rewards of $600 or more to the IRS on Form 1099-K. This applies to cash back, points, and miles — any reward you receive. You'll receive a copy of the form and should report the income on your tax return.

The $600 threshold applies per issuer, not per card. If you have two cards from the same bank and earn $400 on each, that's $800 total and you'll receive a 1099-K. If you have cards from five different issuers and earn $500 from each, you won't receive any 1099-K forms because no single issuer crossed $600. Keep records of your rewards throughout the year so you're prepared when tax time arrives.

Why some merchants prefer debit or cash

Debit card fees are much lower than credit card fees — typically 0.5% to 1.5% — because debit transactions are routed differently and carry less fraud risk. Cash has no processing fee at all. A merchant who processes mostly debit and cash has much lower card fees than one processing mostly credit cards. This is why some small businesses, gas stations, and restaurants offer a discount for debit or cash payments. They're passing along the savings from lower processing costs.

Large merchants like Walmart and Target have enough transaction volume to negotiate lower interchange rates with card networks, but small merchants have almost no negotiating power. A local coffee shop pays roughly the same percentage as a national chain, which is why small merchants are often more sensitive to card fees and more likely to encourage cash or debit payments.

Frequently Asked Questions

Do I pay anything extra when I use a rewards card?

No. You pay the same price at checkout whether you use a rewards card, a basic card, or cash. The merchant pays the interchange fee to the card network, and the card issuer uses part of that fee to fund your rewards. You don't see a separate charge.

Can merchants refuse to accept my rewards card?

Yes. Merchants can choose which card networks they accept. Some small businesses don't accept American Express because the interchange fees are higher. However, if a merchant accepts Visa, they must accept all Visa cards — they can't pick and choose based on the rewards the card offers.

Why do some stores offer cash discounts?

Cash has no processing fee, so the merchant saves money when you pay with cash instead of a card. A 2% or 3% cash discount reflects the merchant's savings on card fees. This is legal, though merchants cannot charge a surcharge for credit card use (with rare exceptions).

If I earn $600 in rewards, do I owe taxes on all of it?

Yes, rewards are taxable income to the IRS. If you earn $600 or more from a single issuer in a calendar year, the issuer will report it on Form 1099-K and you should report it on your tax return. The amount you owe in taxes depends on your tax bracket.

Do points and miles count toward the $600 tax reporting threshold?

Yes. The IRS treats cash back, points, miles, and any other reward the same way for tax purposes. If you earn 50,000 miles worth $600 or more from one issuer in a year, that's reportable income.