Application of Sec. 1341 in the AMT context.

• Author: Walters, Joel
• Position: Alternative minimum tax

It has long been an accepted principle of tax law that when a taxpayer receives income under a "claim of right" the income must be reported for tax purposes. (See North American Oil Consolidated Co., 286 US 417 (1932).1 Derived from the basic proposition that income taxes are determined under an annual accounting system, the claim of right doctrine dictates that amounts received under a claim of right (and without restriction) during a tax year are includable in income without regard to whether the amounts may have to be surrendered in a future tax year.

There is a second rule to this doctrine. If a taxpayer does have to surrender amounts recognized in a prior tax year under a claim of right, the year of recognition is not retroactively modified. Instead, the amount surrendered is allowed as a deduction in the year of repayment. (See Lewis, 340 US 590 (19511.)

The application of these two rules could have inequitable resuits in certain circumstances. For example, if a taxpayer surrenders income recognized in a prior period under a claim of right and is subject to a lower tax rate in the year of surrender than in the year of initial recognition, the resulting deduction does not make the taxpayer whole. To deal with these inequities, Congress enacted Sec. 1341.

Under Sec. 1341, alternative methods are used to determine a taxpayer's tax liability in the year of repayment. The taxpayer's liability is equal to the lesser of --the tax for the tax year computed with the deduction (Sec. 1341(a)(41); or --the tax for the tax year computed without the deduction, minus the decrease in tax for the prior tax year (or years) that would result solely from the exclusion of such item (or portion thereof) from gross income for such prior year (or years)(Sec. 1341(a)(511.

To qualify for Sec. 1341 treatment, three requirements must be met.

* An item must have been included in gross income for a prior tax year (or years) because it appeared that the taxpayer had an unrestricted right to such item (Sec. 1341(a)(11).

* A deduction must be allowable for the tax year because it was established after the close of such prior tax year (or years) that the taxpayer did not have an unrestricted right to such item or to a portion of such item (Sec. 1341(a)(21).

* The amount must exceed $3,000 (Sec. 1341(a)(31).

It is important to note that there are a number of other hurdles that must be met to apply Sec. 1341. Sec. 1341 generally does not apply to any deduction...