Individual Income Tax
Repayment of Claim of Right Income
August 5, 1987
Re: Ruling Request
Claim of Right / IRC §1341
Individual Income Tax
This will reply to your letter of October 10, 1985 in which you request information pertaining to the Virginia tax treatment of adjustments made under Internal Revenue Code §1341 for claim of right repayments and to your letter of May 16, 1986 in which you provide additional information.
The claim of right doctrine, as it has been established as a principle of tax law, provides that payments must be included in gross income if the taxpayer receives them without restriction under a claim of right. This is true even though the taxpayer may discover in a later year that he had no right to the payments and is required to repay the same amount. Under this claim of right doctrine, the taxpayer may deduct the repayments in the year in which they are made.
When the repayments exceed the income for the year of the repayment or when the income (after the subtraction of the repayments) is taxed at a rate lower than that at which the income was taxed in the year of inclusion, the deduction does not compensate the taxpayer adequately for the tax that was originally paid on the inclusion of the income. Section 1341 of the Internal Revenue Code provides a mechanism by which this inequity is corrected in cases in which the repayment exceeds $3000.
Under the provisions of IRC §1341, a taxpayer is allowed to either: (1) reduce the tax for the year of the repayment by the amount to tax attributable to the inclusion of the income in the previous year(s), or (2) to deduct the amount repaid in the year of the repayment. The taxpayer is allowed to use whichever method results in the lower tax liability. In either case, the adjustment is made to the return for the year of the repayment; not to the prior year's return in which the income was included.
In order to maintain conformity with the options available to individuals under the Internal Revenue Code, the department will allow individuals to fully follow the provisions of IRC §1341 for Virginia income tax purposes. This means that the method elected for federal income tax purposes under IRC §1341, to account for the repayment, will determine which method must be used for Virginia income tax purposes.
When an individual chooses to reduce the tax for the year of the repayment by the amount to tax attributable to the inclusion of the income in the previous year(s), a schedule should be attached to the Virginia return detailing the computation of the Virginia tax consequences of the repayment. In addition, a copy of the schedule attached to the federal return, used to compute the federal tax consequences of the repayment, should also be attached to the Virginia return. The amount of tax benefit derived from the repayment should be included on the line of the Virginia return designated for Virginia income tax withheld.
Also, please have your client attach a copy of this letter to his return when he files the return with the department.
If you have any further questions, please do not hesitate to contact me.
W. H. Forst