2.8 Did You Return Wages Received in a Prior Year?

Did you return income in 2012 such as salary or commissions that you reported in a prior taxable year because it appeared you had an unrestricted right to them in the earlier year? If so, you may deduct the repayment as a miscellaneous itemized deduction. If the repayment of wages exceeds $3,000, the deduction is claimed on Line 28 of Schedule A and is not subject to the 2% adjusted gross income (AGI) floor (19.1). However, if the repayment is $3,000 or less, the deduction must be claimed on Line 23 (“Other Expenses”) of Schedule A, where it is subject to the 2% floor.

Option of tax credit or deduction for repayments over $3,000.

If your repayment of wages exceeded $3,000, you may claim the repayment as an itemized deduction, or you may claim a tax credit, based upon a recomputation of the prior year’s tax; see the Filing Instruction on this page.

Filing Instruction

Repayments Exceeding $3,000

If a repayment of wages in 2012 exceeds $3,000, a special law (Code Section 1341) gives this alternative: Instead of claiming an itemized deduction from 2012 income, you may recompute your tax for the prior year as if the wages had not been reported. The difference between the actual tax paid in the prior year and the recomputed tax may be claimed as a credit on your 2012 return. The credit is claimed on Line 71 of Form 1040; write next to the line “IRC 1341.” If you claim the repayment as a miscellaneous itemized deduction, enter it on Line 28 of Schedule A, where it is not subject to the 2% floor. Choose either the credit or the itemized deduction, whichever gives you the larger tax reduction.

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Repayment of supplemental unemployment benefits.

Where repayment is required to qualify for trade readjustment allowances, you may deduct the repayment from gross income. Claim the deduction on Line 36 of Form 1040, and to the left of the line write “sub-pay TRA.” The deduction is allowed even if you do not itemize. If repayment exceeds $3,000, you have the choice of a deduction or claiming a tax credit based on a recomputation of your tax for the year supplemental unemployment benefits were received, as explained in the Filing Instruction on this page.

Repayment of disallowed travel and entertainment expenses.

If a “hedge” agreement between you and your company requires you to repay salary or travel and entertainment (“T & E”) expenses if they are disallowed to the company by the IRS, you may claim a deduction in the year of repayment. According to the IRS, you may not recalculate your tax for the prior year and claim a tax credit under the rules of Section 1341. However, an appeals court rejected the position taken by the IRS and allowed a tax recomputation under Section 1341 to an executive who returned part of a disallowed salary under the terms of a corporate by-law.