How Returning a Portion of Your Signing Bonus Affects Your TaxesAugust 26, 2015
Retiring early and you've paid tax on the full amount of your signing bonus? There are tax implications you need to know about.
Since the end of the 2014 NFL season, and prior to the start of the 2015 NFL season, several players have announced their retirement from the NFL although they remained under contract for future years.
One of the more publicized retirements was that of Chris Borland of the San Francisco 49ers. Borland signed a contract with the 49ers in 2014 that included a signing bonus of $617,436, which appears to have been paid in full at the time the contract was signed (or shortly thereafter). After playing just one year under this contract, Borland announced his retirement and his intent to repay the unearned portion of his signing bonus, 75% or $463,077 (actually, he may have had no choice but to repay the unearned portion of his signing bonus based upon the language in most player contracts, as well as the CBA).
How are returns of bonuses treated?
So what happens with this $463,077 from an income tax perspective? After all, he would have reported the full sign on bonus on his 2014 income tax return as taxable wages. Does he just go back and amend his 2014 income tax return and correct the amount of income reported from the signing bonus? Although this seems like the obvious answer, it is not the right answer. The proper treatment is to actually take a deduction in the year of payment under the “claim of right” doctrine.
The claim of right doctrine is codified in §1341 of the Internal Revenue Code. This code section allows a deduction when a taxpayer receives a payment in one year to which they have what appears to be an unrestricted right and, in a subsequent year, the taxpayer is required to repay the amount because he/she did not, in fact, have a right to it. Under the claim of right doctrine, assuming the repayment exceeds $3,000, the taxpayer’s tax in the year of deduction will be the lesser of:
- The tax computed for the year of repayment with the repayment claimed as a miscellaneous itemized deduction not subject to the 2% floor. OR
- The tax computed for the year of repayment without the repayment claimed as a deduction, less the amount of tax that would have been saved in the year the income was originally reported had the original payment not been included (i.e. the difference in tax for the year the payment was included calculated both with and without the payment)
In Borland’s case, this means the following calculations will need to be performed and compared for 2015:
- 2015 income tax claiming a miscellaneous itemized deduction of $463,077. Compared to:
- 2015 income tax computed without any deduction for the repayment less the difference in the amount of tax for 2014 calculated with and without $463,077 of the signing bonus included as taxable income
Borland’s 2015 tax should equal the lesser of (1) or (2).
Conceptually speaking, these calculations under the claim of right doctrine are supposed to put a taxpayer in the same position that he/she would have been in had the income never been received and the repayment never made.
- There are certain requirements that must be satisfied in order to qualify for the benefits of §1341, all of which it would appear a taxpayer like Borland would meet. These requirements are:
- The income must have been included in gross income in a previous year;
- The income was included because it appeared the taxpayer had an unrestricted right to the income;
- The repayment occurs because it is established after the year of inclusion that the taxpayer did not have an unrestricted right to the income; and
- The repayment amount exceeds $3,000
Additional calculations may be required if, in the year of repayment, the deduction results in a net operating loss (“NOL”), which essentially means trade or business deductions exceed trade or business income. A discussion of these additional calculations is beyond the scope of this blog.
Wouldn’t it be simpler to just allow a Borland, or others like him, to file an amended return for 2014?