Discussion Archives:Claim of Right ... or what?

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Discussion Forum Index --> Advanced Tax Questions --> Claim of Right ... or what?

Discussion Forum Index --> Tax Questions --> Claim of Right ... or what?

PDXTaxman (talk|edits) said:

12 September 2008
Hey folks, HELP! Sorry for the length of this question, but I've got a problem here that's pushing my pay grade. Unless I'm missing something, my poor client is going to get walloped with about $8,000 in federal taxes that -- by every reasonable measure -- he genuinely shouldn't have to pay. So I'm hoping I AM missing something, and one of you can give me a pointer to the right direction.

Here's the situation: in 2002, the client suffered a debilitating illness. In 2003 he went on permanent disability. His firm's LTD (Long Term Disability) insurer paid him about $35K in 2003, 2004 and 2005 each, and $17K in 2006.

In 2006, the Social Security Administration granted his disabled status retroactive to 2003. Note that he was very, very sick those years, and didn't file returns after '03. He's already lost a $900 refund for 2004 for want of timely filing.

When SSA approved his disability status, they sent him a check for $64K. The LTD insurer promptly demanded a refund of $52,000 for 2003-2006, which he paid immediately. Although they had paid him $17K in 2006, they designated only $3K as repayment for that year.

Just to make this more interesting, in 2006 he cleaned out a large pension fund of $45K, on top of other IRA and pension payments. So on paper he made $130K that year.

Of course you know how this is going: I put the $3K LTD repayment (designated for 2006) as negative income under Miscellaneous Income. But the rest of the $52K repayment (about $49K) went onto Schedule A. Because his apparent income (including the immediately-surrendered $52,000) comes in at a hefty $130K total, his Schedule A employee expenses deduction is reduced by 2% ($2,600). That's unfair on the face of it, a rotten part of the tax code but hardly a catastrophe.

HOWEVER, in this case our client -- thanks to that artificially-high $130K income level -- has been thrown well into AMT territory. And AMT is adding nearly $8,000 in additional federal tax to the total. I am facing the incredibly unpleasant prospect of having to tell him he owes about $10,000 in taxes total for the year, plus penalties and interest. This is all pure double taxation, every nickel of it!

The client helpfully referred me to Claim of Right, IRC Code 1341. Well, yeah, I know about it. In fact I have an interesting New York CPA Journal article here about it. According to that, we at least ought to be able to have him taxed at the marginal tax rate he WOULD have been taxed at had he not received the income. I'm sure I can calculate the difference in his taxes, but that still begs the question how to report it (on the return, via Lacerte).

So here are my questions:

1. Is there ANY acceptable way to allow us to deduct all or more of that $52 LTD repayment against the 2006 income directly, essentially as negative income, instead of on Schedule A?

2. We've prepared but not handed over his '04 and '05 tax returns. No benefit from meddling with 2004 ... he was already up for a refund, and that's past. But 2005 is still open, and as it happens he owes about $4,000 for that year, too. So is there any way to do a carry-back of some sort?

3. If nothing else, notwithstanding the LTD insurer's declaration that only $3,000 of his repayment applied to 2006, he actually received over $17K from them that year. Can we legally get away with deducting ALL of that as LTD repayment? Or is that just asking for an audit that would go against him?

4. Is there some provision of the AMT code that will give me an out? I couldn't find one, but hope springs eternal.

5. And that Claim of Right matter: if nothing else, I'd save him a few bucks by getting the income taxed at a lower marginal rate. How do I actually report such a calculation using Lacerte?

Thanks in advance for any help! (By the way, at least his 2007 return is looking like a nice refund).

Death&Taxes (talk|edits) said:

12 September 2008
1. No

Negative income? Can't be done unless I am misunderstanding you; repayments are Schedule A

4. What is the AMT Code, is this different from the Internal Revenue Code. Repayments are miscellaneous deductions not subject to the 2% limit and are not eliminated for AMT. See Publication 525

5. Override and attach a computation.

RoyDaleOne (talk|edits) said:

12 September 2008
I can not tell from your post however the repayment under a claim of right is not subject to the 2% floor.

Waynecpa (talk|edits) said:

12 September 2008
Just a thought - have you looked into the lump sum election for social security? This could bring your taxable income down for 2006.

PDXTaxman (talk|edits) said:

12 September 2008
Hi all,

Duh, of COURSE it's not subject to the 2% limit. I was thinking of the rule for repayments <$3,001. Well, it was rather late last night ....

Furthermore, after re-reading the materials I had pulled on it, I realize it's an either/or situation. Put it on Sch. A, line 28, OR do the Claim of Right (IRS 1341) calculations (reported as a credit on Line 70). Can't do both.

Negative income? Imprecise language. Sorry. (Same with "AMT Code." Okay, "provisions" or "rules"). But the tax code does provide that repayments made in the same year as the income received may be netted. I can't just subtract $3K from the W2 reported amount in Box 1 on Lacerte’s Screen 10. I was taught years ago to, in these cases, enter a negative number in Box 21 (miscellaneous income) of the 1040, marked as a repayment. A negative number, not "negative income." I don't see where either the The TaxBook or Lacerte's instructions even address how to do this in any other way.

My question was whether there was any legal way to do this with amounts received in prior years and, Death&Taxes, you supported my glum conclusion that there isn't. Thank you for the confirmation.

So that still leaves the big issue: $49K in income that's not real, yet nonetheless is pushing the client into an AMT tax of $8,000. A true example of double taxation. So, thank you Waynecpa. I'll be running to the IRS pubs this morning to check out lump sum elections on SS to see if that might help.

RoyDaleOne (talk|edits) said:

12 September 2008
Huh? PDXTaxman your posts are not making sense. Why do you AMT of $8k? Deduction not subject to the 2% are NOT added to regular taxable income for AMT purposes.

Death&Taxes (talk|edits) said:

12 September 2008
Check out the discussion from earlier this week: Discussion: Weird Social Securoty Disability Question

Osutaxman (talk|edits) said:

12 September 2008
Section 1341 will come into play here. Repyment of previously reported income over 3,000.

Choice will be to either:

1-deduct in year of repayment

or take a credit for the amount of tax difference (for the previous years) lacerte=screen 60

2-take the deduction in year of repayment
I would take the deduction on Other Income line. Labeled "Repayment of Previously reported income"

I would assume you will be choosing choice number two because of the amount of Income in tax year and the deduction will be more important than the credit

I had a claim-of-right adjustment once that had to do with Capital gain.....The offsetting deduction was difficult because software wanted to limit, because of Capital loss limitations

Death&Taxes (talk|edits) said:

12 September 2008
Publication 525 "If you reported it as wages, unemployment compensation, or other nonbusiness income, deduct it as a miscellaneous itemized deduction on Schedule A (Form 1040)."

You would only report business or farm income repayments on the Sch C or F, or Schedule D items on the D.

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