Discussion:Wage bonus repaid in following yr

The employee would report it as either a 2% misc deduction or as a §1341 credit.

If there was an unrestricted right to the money, he wouldn't have to repay it.

Roy: How would the options be different? You only get the two options since the repayment was greater then $3000, otherwise you'd be stuck with the misc deduction.

All sign on bonsus I have seen are under a very real repayment restriction. It probally shouldn't have been reported as income in the first place. I've seen a couple that framed as loans, and were forgiven on the aniversery date and included in income in that year.

Repayments. If you had to repay an amount you included in your income in an earlier year, you may be able to deduct the amount repaid for the year in which you repaid it. Or, if the amount you repaid is more than $3,000, you may be able to take a credit against your tax for the year in which you repaid it.

Type of deduction. The type of deduction you are allowed in the year of repayment depends on the type of income you included in the earlier year. For instance, if you repay an amount you previously reported as a capital gain, deduct the repayment as a capital loss on Schedule D (Form 1040). If you reported it as self-employment income, deduct it as a business deduction on Schedule C or Schedule C-EZ (Form 1040) or Schedule F (Form 1040).

 If you reported the amount as wages, unemployment compensation, or other nonbusiness ordinary income, enter it on Schedule A (Form 1040) as a miscellaneous itemized deduction that is subject to the 2% limitation. However, if the repayment is over $3,000 and Method 1 (discussed later) applies, deduct it on Schedule A (Form 1040) as a miscellaneous itemized deduction that is not subject to the 2% limitation. 

Repayment—$3,000 or less. If the amount you repaid was $3,000 or less, deduct it from your income in the year you repaid it.

Repayment—over $3,000. If the amount you repaid was more than $3,000, you can deduct the repayment, as described earlier. However, you can instead choose to take a tax credit for the year of repayment if you included the income under a “claim of right.” This means that at the time you included the income, it appeared that you had an unrestricted right to it. If you qualify for this choice, figure your tax under both methods and use the method that results in less tax.

Method 1. Figure your tax for 2007 claiming a deduction for the repaid amount.

Method 2. Figure your tax for 2007 claiming a credit for the prepaid amount. Follow these steps. Figure your tax for 2007 without deducting the repaid amount.

Refigure your tax from the earlier year without including in income the amount you repaid in 2007.

Subtract the tax in (2) from the tax shown on your return for the earlier year. This is the amount of your credit.

Subtract the answer in (3) from the tax for 2007 figured without the deduction (step 1).

 If Method 1 results in less tax, deduct the amount repaid as discussed earlier under Type of deduction. 

 If Method 2 results in less tax, claim the credit on line 70 of Form 1040, and write “I.R.C. 1341” next to line 70. 

Example.

For 2006, you filed a return and reported your income on the cash method. In 2006, you repaid $5,000 included in your 2006 gross income under a claim of right. Your filing status in 2007 and 2006 is single. Your income and tax for both years are as follows:

 2006 

With Income 2006 Without Income Taxable Income $15,000 $10,000 Tax $ 1,876 $ 1,126

 2007 

Without Deduction 2007 With Deduction Taxable Income $49,950 $44,950 Tax $8,918 $ 7,668

Your tax under Method 1 is $7,668. Your tax under Method 2 is $8,168, figured as follows:

Tax previously determined for 2006 $ 1,876 Less: Tax as refigured - 1,126 Decrease in 2006 tax $ 750 Regular tax liability for 2007 $8,918 Less: Decrease in 2006 tax - 750 Refigured tax for 2007 $ 8,168

Because you pay less tax under Method 1, you should take a deduction for the repayment in 2007.

However, the employee in the OP's situation would be able to take advantage of §1341 even with the Service's flawed position. The signing bonus was paid to the employee with the condition that the employee would not be vested in the bonus until a certain period of employment passed. At the close of the tax year (2007), it was apparent from the facts available that the employee would remain with the employer till the end of the vesting period. If that weren't the case, then the employer would have surely sought repayment in 2007. There was no actual claim of right because the signing bonus was still subject to forfiture. There was only a semblence of a claim of right because the employee was expected to vest.

The second part of the test is that it must be established after the close of the prior tax year, that the taxpayer did not have an unrestricted right to the income. Both parties incorrectly considered that the bonus was paid under an unrestricted right in the prior tax year (2007), otherwise the employer would not have deducted it as employee compensation and included it on the w-2, and the employee would not have reported it as income on his 2007 tax return. It was "discovered" in the later tax year (2008) that the bonus was restricted and repayment would be required. It is not important that the repayment was triggered by the employee's leaving. The crux of the issue is that the bonus was subject to the restriction in the first place, regardless of when it was triggered, and that the parties regarded it as unrestricted in the year of payment.