At times, a taxpayer may receive and report income, and then in a later year have to return the income item. Depending on the circumstances, this could give rise to a deduction in the later year under Code §§162 or 165 under the Claim of Right Doctrine.
If the taxpayer does not have significant income in the year of repayment (or in the NOL carryback or carryforward periods if the deduction is under Code §162), the taxpayer not get much mileage from the deduction due to a lack of income to offset by the deduction. To remedy this situation, Code §1341, when operable, will allow the taxpayer a refund in the year of repayment equal to the tax savings that would have resulted if the initial income reporting was not required, regardless of the amount of income arising in the year of repayment.
A requirement to use Code §1341 is that at the time of the original receipt of money, the taxpayer must have subjectively believed it had an unrestricted right to the money in that year. This is problematic for taxpayers who received the money fraudulently or as the result of criminal activity, since they would lack this subjective belief - thus, they cannot use Code §1341. As an aside, note that repayments as the result of fines or forfeitures may be denied deductibility anyway under Code §§162 and 165.
In a recent appellate decision, the taxpayer had obtained funds through fraud, and through the actions of a receiver, had to disgorge some of those funds. Because those funds were obtained through fraud, Code §1341 cannot apply. Nonetheless, the receiver, on behalf of the taxpayer, made a Code §1341 refund claim so as to increase funds available to the victims of the taxpayer. When challenged by the IRS, the receiver was able to convince the trial court that this Code §1341 limitation regarding subjective belief of an unrestricted right to the money was not applicable when the refund claim was made by the receiver and not the taxpayer, based on the equitable purposes of Code §1341 and the equitable actions of the receiver.
The federal First District Court of Appeals recently acted to reverse the trial court, and to deny the refund claim to the receiver. The attempted use of Code §1341 by the receiver was not an equitable purpose that Congress intended to remedy under Code §1341, and thus receiver could not escape its intent limitations.
Robb Evans & Associations, LLC v. U.S., 119 AFTR 2d 2017-XXXX, (CA1), 03/03/2017