Paying back a bonus question (tax implications)

[Bushdog]

So I'm advising someone on what they should do, and *ahem* I'm a little in over my head on one part.

They have the opportunity to sign a two year bonus for $10K. The stipulation of course (as it is in the bonus description) is that if they leave before 2 years they owe the 10K back to the company.

How exactly does that work in terms of tax implications?

Say that in 2006 they get their $10,000 and pay ?2800? of that in taxes. So they pocket 7200. But then in 2007 they need to leave the company. The company will rightly ask for their 10K back (not 7,200).

I've been trying to run this all through in my head but it seems like there'd be at least some loss of money for the employee.

I'd love any guidance.

[OldDude]

I don't know. My company paid me a foreign service bonus, then a situation arose that I had to turn down the foreign service assignment.

They had me pay back the after-tax amount and they reversed the transaction in payroll records, getting the tax money back (or lowering their next payment). The difference is that it was also in the same tax year for both me and the company.

Nearly two years later, I have no clue what would happen. Probably warrants "real" tax advise from a professional, not Otters.

[Bushdog]

Thanks.

Yah, I'm sure it does involve real tax advice. I figure I'd start here, the occasionaly CPA does wander by.

Same year and I'd be less worried, multiple years must get complicated.

[Duran]

My first thought would be you'd amend your first year's return and get back the taxes paid on it. Non-professional guess, though.

[Bushdog]

Originally Posted by Duran

My first thought would be you'd amend your first year's return and get back the taxes paid on it. Non-professional guess, though.

That's an interesting thought. Thanks.

[X]

Being on a cash basis and having actually received the money in a past year makes me think you wouldn't amend your old tax return.

I think you'd just take the repayment off your current return when you paid it back.

[Bushdog]

Originally Posted by X

Being on a cash basis and having actually received the money in a past year makes me think you wouldn't amend your old tax return.

I think you'd just take the repayment off your current return when you paid it back.

Which seems like you net lose money then, no?

[X]

Well, always wanting to know what the IRS says about these matters sent me to look it up at their site.

Repayments
If you had to repay an amount that you included in your income in an earlier year, you may be able to deduct the amount repaid from your income for the year in which you repaid it. Or, if the amount you repaid is more than $3,000, you may be able to take a credit against your tax for the year in which you repaid it. Generally, you can claim a deduction or credit only if the repayment qualifies as an expense or loss incurred in your trade or business or in a for-profit transaction.

Type of deduction. The type of deduction you are allowed in the year of repayment depends on the type of income you included in the earlier year. You generally deduct the repayment on the same form or schedule on which you previously reported it as income. For example, if you reported it as self-employment income, deduct it as a business expense on Schedule C or Schedule C-EZ (Form 1040) or Schedule F (Form 1040). If you reported it as a capital gain, deduct it as a capital loss on Schedule D (Form 1040). If you reported it as wages, unemployment compensation, or other nonbusiness income, deduct it as a miscellaneous itemized deduction on Schedule A (Form 1040).

Repayment of $3,000 or less. If the amount you repaid was $3,000 or less, deduct it from your income in the year you repaid it. If you must deduct it as a miscellaneous itemized deduction, enter it on Schedule A (Form 1040), line 22.

Repayment over $3,000. If the amount you repaid was more than $3,000, you can deduct the repayment (as explained under Type of deduction, earlier). However, you can instead choose to take a tax credit for the year of repayment if you included the income under a claim of right. This means that at the time you included the income, it appeared that you had an unrestricted right to it. If you qualify for this choice, figure your tax under both methods and compare the results. Use the method (deduction or credit) that results in less tax.

Method 1. Figure your tax for 2005 claiming a deduction for the repaid amount. If you must deduct it as a miscellaneous itemized deduction, enter it on Schedule A (Form 1040), line 27.

Method 2. Figure your tax for 2005 claiming a credit for the repaid amount. Follow these steps.
Figure your tax for 2005 without deducting the repaid amount.

Refigure your tax from the earlier year without including in income the amount you repaid in 2005.

Subtract the tax in (2) from the tax shown on your return for the earlier year. This is the credit.

Subtract the answer in (3) from the tax for 2005 figured without the deduction (Step 1).

If method 1 results in less tax, deduct the amount repaid. If method 2 results in less tax, claim the credit figured in (3) above on Form 1040, line 70, and enter “I.R.C. 1341” next to line 70.

An example of this computation can be found in Publication 525.

http://www.irs.gov/publications/p17/ch12.html#d0e30860

It appears he wouldn't have the Method 2 option as it doesn't appear he had an unrestricted right to the bonus.

The details can be found here (page 32 in particular):

http://www.irs.gov/pub/irs-pdf/p525.pdf

[Bushdog]

Thanks, X. I'll have to give it a read.

[X]

Originally Posted by Bushdog

Which seems like you net lose money then, no?

Wouldn't he have any other income (probably even income from the same employer) to deduct it from? He'd be deducting the same amount that he paid taxes on in an eariler year.

It would only be a loss of money if he were in a lower tax bracket when he got the deduction and then it would just be a loss of some taxes. He would have had the benefit of the money for a year or two which should be worth something.