When a taxpayer receives an amount as, for example, compensation for services or proceeds from the disposition of property, and it appears that the taxpayer has an unrestricted right to that amount, the “claim of right” doctrine generally requires that the amount must be included in the taxpayer’s gross income no later than the year of receipt. “Things” happen, however, and the taxpayer may be called upon to repay the amount received.

Even when overarching principles of tax accounting allow the taxpayer to claim a deduction in the year of repayment, the tax benefit of that deduction is often less than the tax cost of the income inclusion in the prior year. In order to mitigate this unfortunate situation, the special rule of §1341 of the Internal Revenue Code (Code) is applicable when: a person receives an amount (“item”) included in gross income when received, because it appears that the person had an unrestricted right to the item; it is determined after the end of the year of receipt that the person did not have an unrestricted right to the item; and the person then relinquishes the item or portion thereof and is consequently entitled to a deduction.