Section 1341 does not apply to canceled debts that you had to claim as income in a previous year when a creditor has a continuing right to pursue you for payment, even after the debt has been forgiven. Nor does it apply to small business owners who reimburse customers for returns. The key term in both these cases is that you did not have an “unrestricted right” to the income when you received it and reported it on your tax return. It was subject to possible repayment terms. Section 1341 does not apply to canceled debts that you had to claim as income in a previous year when a creditor has a continuing right to pursue you for payment, even after the debt has been forgiven. Nor does it apply to small business owners who reimburse customers for returns. The key term in both these cases is that you did not have an “unrestricted right” to the income when you received it and reported it on your tax return. It was subject to possible repayment terms. The Section 1341 credit lets you avoid filing an amended tax return for the year in which you claimed the income. But the key here is filing an amended return. Claiming the credit isn’t just a simple matter of checking a box on your current tax return. You must still roll up your shirtsleeves and redo your Form 1040 tax return for the year in which you claimed the payment as income. This time, you won’t include that income you were forced to repay. Your credit amounts to the difference in tax when that reimbursed payment is removed from the equation. Your state might also recognize a claim-of-right doctrine if you included this type of income on a previous year’s state tax return. For example, Massachusetts allows its taxpayers to claim a deduction on a subsequent year’s return for money they repaid in that year they weren’t entitled to. Check with a local tax professional to find out where your state stands on this issue.
Example of the Section 1341 Credit
Say you received a $5,000 payment from your employer that was unrestricted. It was yours to keep, no matter what. But then the money turned out to be restricted due to factors not known at the time, so you were obligated to reimburse that $5,000 to your employer. However, you already reported it as income when you were in a 24% marginal tax bracket. You paid taxes on that income at that rate. You therefore can claim a credit for that $5,000 on your tax return if your marginal tax rate is now lower, say at 22%.
Requirements for Claiming a Section 1341 Credit
You must file Schedule 3 with your tax return to claim the Section 1341 credit. This is the “Additional Credits and Payments” form. Enter the calculated amount of your credit on Line 13d on the second page of the tax form. Write “IRC 1341” in the box beside the line. The total for all payments and credits entered on Page 2 of Schedule 3 is entered on Line 14, then transferred to Line 31 of your Form 1040 tax return. You can claim the credit in the same year you made the repayment if you use the cash method of accounting, which is typical for most individual taxpayers.
Alternatives to a Section 1341 Credit
Before the enactment of the Tax Cuts and Jobs Act (TCJA) in late 2017, you could claim a Section 1341 credit on a subsequent tax return, or you could claim the repayment as an itemized miscellaneous deduction if it was less than $3,000. But the TCJA eliminated most itemized miscellaneous deductions from the U.S. tax code, at least through the end of 2025, when the law potentially expires. Now, your only recourse in this situation is the Section 1341 “claim of right” credit, assuming you qualify to claim it. Section 1341 of the Internal Revenue Code addresses “repayment of income previously reported.”
