Overview
Taxpayers who have paid Massachusetts personal income taxes in a prior year on income attributed to them under a Claim of Right may deduct the amount of that income from their gross income if it is later determined that they weren’t entitled to the income and have repaid the amounts in question.
The deduction is allowed in the year of repayment, provided the amount was previously included in Massachusetts taxable income and the repayment isn’t otherwise deductible in determining Massachusetts income.
Since Massachusetts already allows for certain deductions under
- I.R.C. §§ 62 (relating to trade or business expenses) and
- 404 (without regard to § 265),
the Claim of Right deduction may be taken only if amounts repaid weren’t otherwise deductible.
Federal Rules
Under the federal Claim of Right guidelines*, taxpayers receiving income under a Claim of Right and without restrictions on its use or disposition will be taxed on that income in the year of receipt even though the right to retain the income isn’t yet fixed or they may later be required to return it.
If taxpayers later repay amounts received under a Claim of Right because they didn’t, in fact, have a right to it, they may be entitled to a deduction federally in the year of repayment* for the amount repaid that was included in the earlier year's gross income.
Please note the original return should not be amended. The deduction should be taken in the year of repayment.
* See IRS Publication 525
Massachusetts Rules
Since Massachusetts gross income for a tax year is federal gross income for the same period with modifications not relevant here, any amount included in taxpayers' federal gross income for the taxable year under a Claim of Right must also be included in their Massachusetts gross income for the same taxable year.
If taxpayers later repay amounts received under a Claim of Right because they didn’t, in fact, have a right to it, they may deduct the amount of that income from their Massachusetts gross income in the year of repayment.
Massachusetts already allows for certain deductions under:
- I.R.C. §§ 62 (relating to trade or business expenses)
- 404 (without regard to § 265), see G.L. c, 62, s. 2(d)(1)
The Claim of Rright deduction might be taken only if amounts repaid weren’t otherwise deductible under that subsection.
Prior Year Returns
Prior year returns aren’t being reopened. As a result, a taxpayer may not adjust their Massachusetts gross income for an earlier year based on a subsequent repayment of amounts held under a claim of right by filing an amended return for that year.
Since the number of available Massachusetts income tax deductions is limited, and there was previously no specific deduction for amounts included under a Claim of Right, taxpayers often couldn’t reduce gross income in the year of repayment by the amount repaid.
Application of Claim of Right Guideline Examples
- Stock under a claim of ownership:
- Gains from sales of stock under a claim of ownership must be included in gross income regardless of whether the taxpayer actually owns it. Pollock v. CIR, 45 TMC 12 (1985)
- Employment Contracts:
- Amounts in settlement of employment contracts must be included in gross income notwithstanding the prospect of eventual repayment to the employer of an amount equivalent to or greater than the amount received. Satz v. CIR, 25 TCM 1578 (1975);
- Dividends:
- Where a taxpayer receives a dividend that must be repaid in a later year (e.g., because it impaired corporate capital), the dividend must be included in the year of receipt. Duffy v. CIR, 2 TC 569 (1943)
- Corporate Notes:
- The taxpayer receives a distribution concerning the holding of notes; the income must be included regardless of whether it could be challenged by senior creditors. Nordberg v. CIR, 79 TC 655 (1982)
- Mistake in Validity of Claim:
- The claim of right guidelines apply where a taxpayer merely mistakes the validity of his claim. United States v. Lewis, 430 U.S. 590 (1951)
- Advanced Insurance Commissions. Security Associates Agency v. CIR, TC Memo 1987-317;
- Repayment of unemployment compensation and supplemental unemployment benefits in a subsequent year
Reporting Claim of Right on Your Tax Return
The amount allowed is entered on Mass. Form 1 or Form 1-NR/PY, Schedule Y, Line 14.
Additional Information
Massachusetts References
- M.G.L. c. 62, ss. 2(d)(1); 3(B)(a)(14) as amended by Acts 2005, c. 163, s. 5
- TIR 06-4: Deduction for Income upon which Taxes Have Been Paid under a Claim of Right
Federal References
- I.R.C. §§ 162, 212, 1341(a)(2)
Page updated: May 7, 2021