Claim of Right Repayment Credit - Help for Section 1341 5(B) clarification

[joshuabarksatlcs]

TP is a professor with W2 and Sch C income.  Employment contract limits his moonlighting income.

In 2021, Employer exercises the claw-back provisions and claims $300K of back payment from TP for 2012 thru 2020.      

Tax law allows either a Sch A misc deduction OR a credit (based on the year-to-year differences between As-filed-and-paid and What-if).

Section 1341:  

(5)(B)......[related to the credit computation]

For purposes of paragraph (5)(B), the corresponding provisions of the Internal Revenue Code of 1939 shall be chapter 1 of such code (other than subchapter E, relating to self-employment income) and subchapter E of chapter 2 of such code.

I'm old but not old enough to remember IRC of 1939.  The clause seemed to exclude certain elements related to Self Employment Income (Chapter 1, subchapter E) and include Chapter 2 and Subchapter E, whatever it is.

Regs 1-1341 parrots the two sections without explaining it.  "Self-employment income" or "SE tax" is NOT found in the text.

I downloaded 

UNITED STATES
STATUTES AT LARGE
CONTAINING THE
LAWS AND CONCURRENT RESOLUTIONS
ENACTED DURING THE FIRST SESSION OF THE
SEVENTY-SIXTH CONGRESS OF THE UNITED STATES OF AMERICA
1939

from the internet.

The IRC on there had Chapter 1 Subchapter A thru C; and Chapter 2 Subchapter A thru D.

NO idea what "Internal Revenue Code of 1939, chapter 1 (other than subchapter E, relating to self-employment income) and subchapter E of chapter 2 of such code" are.

Help....Community Ideas

1.  For the Claim of Right Repayment Credit under Section 1341, can the TP claim the credit for the excess Self Employment Tax on the repaid income?

2.  Do you know what "Internal Revenue Code of 1939 chapter 1, subchapter E (relating to self-employment income) and subchapter E of chapter 2 of such code" are?

(The instructions on Pub 525 and other materials discuss "Tax" without addressing the applicability to Self Employment Tax in this regard.)

[BobKamman]

You're leaving out a subparagraph header.  The citation should be:

Section 1341(a)(5)(B) 

Most of the time federal statutes are number, letter, number, letter.  First ulc, then caps.  Then I think they get into Roman numerals, but I would have to look for one to be sure. 

The reference to the 1939 Code is in artifact from 1954 (and then 1986) in case you had any years that go back that far.  Ignore it.  

[joshuabarksatlcs]

Yes, it's Section 1341(a)(5)(B).   the (a) Got deleted during editing.  Mea Culpa.

Yet, the reference is to the 1939 Act, which has no such Subchapters. 

The 1954 Act then 1986 Act 's Subchapter 1, Subchapter E has to do with "Accounting Method" etc. , and Chapter 2 has NO specific subchapters. 

I thought the reference in the the current Code 1341(a)(5)(B) has to do with a version of the "1939 Act" between 1939 and 1954.    Still this would not help me for my question:

1.  For the Claim of Right Repayment Credit under Section 1341, can the TP claim the credit for the excess Self Employment Tax on the repaid income?

[BobKamman]

The 1939 Code did have such a subchapter by the time it was replaced in 1954.  You won't find it in an online edition that was published in 1939.  But you don't need it, because you just need to use the 1986 Code for tax years beginning in 2012.  

[joshuabarksatlcs]

Still the reference doesn't make sense.

For the 1986 Code:

Chapter 1 has Subchapter A thru  Y - Subchapter E being "Accounting periods and methods of accounting".

Chapter 2 - Tax on Self-employment Income has  three section (Sec 1401 thru 1403).  NO subchapter.

Section 1341(a)(5)(B):

.....

For purposes of paragraph (5)(B), the corresponding provisions of the Internal Revenue Code of 1939 shall be chapter 1 of such code (other than subchapter E, relating to self-employment income) and subchapter E of chapter 2 of such code.

The above would make sense if it said: (It would (i) exclude the accounting period per Subchapter E due to the nature of the claim of right repayment; and (ii) include Self-employment tax for the credit.)

For purposes of paragraph (5)(B), the corresponding provisions of the Internal Revenue Code of 1939 shall be chapter 1 of such code (other than subchapter E) and chapter 2 of such code (relating to self-employment income).

.....  Still digging into it.  The 1939 Code right before 1954.  

@BobKamman  really appreciate your input!!

[BobKamman]

There are tracking lists that tell you where a section in the 1954 Code was found in the 1939 Code. I don't know if any of them tell you how the chapters and subchapters were renumbered because no one back then thought anyone would ever be interested in it.  

[qbteachmt]

I don't see how this applies to SE tax: "Employer exercises the claw-back provisions and claims $300K of back payment from TP for 2012 thru 2020."

The employer cannot claw back Self-employment income. The Employer can "dock wages" per the contract. That means the employee's share of SS and Medicare would be refunded from the Employer, the same as a cancelled, claw back bonus. The claw back is the Wage earnings, not the Sched C earnings, isn't it?

Read these scenarios for comparison: https://ttlc.intuit.com/community/taxes/discussion/re-the-repayment-must-be-more-than-3000-the-amoun...

[qbteachmt]

For affecting SE tax or not, I found this:

The repayment is deducted, in general, on the same form or schedule on which it was previously included. If it had been included as self-employment income on Schedule C, Profit or Loss from Business, it is deducted on Schedule C. If it had been included as capital gain on Schedule D, Capital Gains and Losses, it is deducted on Schedule D. If it was reported as wages, taxable unemployment compensation, or other non-business ordinary income, it is deducted on Schedule A, Itemized Deductions.

Here: https://www.irs.gov/irm/part21/irm_21-006-006r

[joshuabarksatlcs]

RE: I don't see how this applies to SE tax

This was in my original post:

"Employment contract limits his moonlighting income.

In 2021, Employer exercises the claw-back provisions and claims $300K of back payment from TP for 2012 thru 2020. "     

Per the employment contract, when the moonlighting income exceeds certain level, he has to split the moonlighting income with the employer.   The claw-back was on the moonlighting income, i.e. the SE income. 

The employer did not dock the wages.  It was not like he lost money from the cash register...

[qbteachmt]

This: "he has to split the moonlighting income with the employer."

is what was missing. Can't you list that as a Sched C expense for the cash basis tp? It sure seems more like a claim than a claw back.

[joshuabarksatlcs]

RE: The repayment is deducted, in general, on the same form or schedule on which it was previously included. If it had been included as self-employment income on Schedule C, Profit or Loss from Business, it is deducted on Schedule C. If it had been included as capital gain on Schedule D, Capital Gains and Losses, it is deducted on Schedule D. If it was reported as wages, taxable unemployment compensation, or other non-business ordinary income, it is deducted on Schedule A, Itemized Deductions.

********************************************************

Here is the text for Section 1341(a)  - didn't edit out (a) this time, hahahaha...

(a)General rule

If—

(1) an item was included in gross income for a prior taxable year (or years) because it appeared that the taxpayer had an unrestricted right to such item;

(2) a deduction is allowable for the taxable year because it was established after the close of such prior taxable year (or years) that the taxpayer did not have an unrestricted right to such item or to a portion of such item; and

(3) the amount of such deduction exceeds $3,000, then the tax imposed by this chapter for the taxable year shall be the lesser of the following:

(4) the tax for the taxable year computed with such deduction; or

(5)an amount equal to—

(A) the tax for the taxable year computed without such deduction, minus

(B) the decrease in tax under this chapter (or the corresponding provisions of prior revenue laws) for the prior taxable year (or years) which would result solely from the exclusion of such item (or portion thereof) from gross income for such prior taxable year (or years).

For purposes of paragraph (5)(B), the corresponding provisions of the Internal Revenue Code of 1939 shall be chapter 1 of such code (other than subchapter E, relating to self-employment income) and subchapter E of chapter 2 of such code.

*******************************************************************************

@qbteachmt , your quoted text above would be the deduction (yes, on Schedule C) under Section 1341 (a)(2) (deduction amount = the claim of right repayment), which is basically the amount for Section 1341(a)(4).

I was computing the credit under Section 1341(a)(5).  TP may claim a deduction under (a)(2) or a credit under (a)(5).  If you look further down from the instructions that you quoted, you should also see something about a credit.

The problem I have is that for the purpose of the credit, (a)(5) refers to something that I couldn't make sense of.  For the purpose of the credit, it's NOT clear to me whether the difference under (5) - that is between (5)(A) and 5(B) would include SE Tax.

 The tax benefit for the credit is much higher than the deduction.  The deduction would make the taxable income a low amount and the tax benefit would thus be generated at the lower tax rates.

IF SE tax was relevant, the deduction would make the SE income for 2021 negative.  thus NOT the full amount would generate tax benefit from the SE tax difference (for the credit).

Tax credit - based on Sec 1341(a)(5) - is computed by the difference of With and Without the excess (claimed) amount  for each year.  The difference for each year would be computed at TP's top rate.

Section 1341(a) allows either a deduction OR a credit.  @qbteachmt  thanks for your info, but you addressed just the deduction, and NOT the credit (with the higher tax benefit).

The addition tax benefit from claiming the credit (even without the SE tax) would be at least 15% of the $300K repayment.  (federal and state)

[joshuabarksatlcs]

The said Employer also paid part of the consulting income. 

The claim was part claw back and part claim of right.  I didn't put down all the details. 

The title of my post was "Claim of Right Repayment".  I thought the claim of right element was understood and clear, but I guess I should not have refrained from TMI....    

[BobKamman]

What does the employment contract say?

"For every dollar of outside income, your salary is reduced", or

"We will always pay your full salary, but you have to turn over every dollar of outside income." ?

If he gets to keep the Schedule C income but his salary is reduced, it's a simple problem.  He qualifies for a refund of FICA and Medicare taxes paid on the salary.

Were there any years where outside income exceeded salary?  Would he have had to pay back more than his W-2 compensation?

First step would be to read the employment contract.  

[joshuabarksatlcs]

All that was done.  The claim was on the moonlighting income.   The W2 was intact. 

The moonlighting income over a certain has to be split.  All about the Sch C income.

[qbteachmt]

"The said Employer also paid part of the consulting income."

My comment was that this seems almost like a Commission agreement, and not a claw back. The deduction would be general business expense in the year paid, not repayment credit under claim of right. And a customer asking for their money back is a refund, not a claim of right.

"The claim was part claw back and part claim of right."

It seems like you have a lot of moving parts to segregate.

[joshuabarksatlcs]

There are NO moving parts.  The only issue was what I posted, whether or not SE Tax was in the computation.  It is ALL about the last paragraph of Section 1341(a)(5)(B).

When I posted a question, please just take it at the face value and no need to read other things into it.

I did NOT ask: TP had claim or right repayment.  What should I do, for crying out loud.

Though I thank you all for your concern.

If you do not have anything to add about whether 1341(a)(5)(B) refers to SE tax, based on the language as finalized, I'll wrap this up and thank you.

[BobKamman]

It occurred to me that this may be a school whose employees don't have Social Security coverage.  He should still be paying Medicare taxes, though, and that may have already been refunded, or figured into the calculation of how much he has to turn over.  I doubt they would be required to amend W-2 forms.  What's interesting is that if this were a straight compensation case -- repayment of a sign-on bonus, for example -- he could have already started collecting SS benefits based on the higher income, and those may not be clawed back. 

Still sounds like a salary reduction to me, rather than a partnership agreement involving outside income.  But IRS may not take too close a look at it.  There were a lot of Section 1341 fraudulent claims a while back that made it through the system.  I haven't heard that they have enough people to tighten up the reviews.  

[qbteachmt]

I see this as a false dichotomy. You want this to be only a credit or an itemized deduction under claim of right, but those are not the only options. If the payments to the school for the excess SE had happened in each year, the self-employment would have been reduced by the expense to the school. That doesn't make it a claw back. As for it being historic years, a cash basis tax payer incurs that cost when it is paid. That means it is not under the claim of right credit or itemized deduction. You did not really ask whether or not SE Tax was in the computation, but how it is included, because you didn't find it stated in the text of the section you want to reference. Yet, the IRM instructions points out it goes to the original income forum, so on Sched C means it will affect SE by reference.

"If you do not have anything to add about whether 1341(a)(5)(B) refers to SE tax, based on the language as finalized, I'll wrap this up and thank you."

You presented a pretty specific scenario with what appears to be different parts. The question you present for 1341 seems to be first to determine whether it applies to all, some, or none of your scenario. Unless this was only for discussion's sake. You can see how this Q&A has resulted in revealing details that matter, as we went along. I hope that was useful. Sorry no one has given you a definitive enough answer.

[amizan]

@joshuabarksatlcs 

What did you end up finding out?

I have the same exact issue. i have been looking for the answer on this for hours and i cannot find a straight answer

But It makes sense that the 1341 credit also applies to SE tax applied in a previous year for the following reason:

Publication 525 page 37 - bottom right hand corner: It does not refer to SE tax but it does say that W2 employees that had a clawback of wages and claimed section 1341 credit for tax, can ALSO apply for a refund of FICA from the employer or alternatively file form 843 to get that money back. So my reasoning goes that if in a  W2-related clawback you can claim back the FICA paid, then in a Schedule C-related clawback, you can also claim back the SE Tax.

That's as close as i get with it. Input?