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. For instance, if you repay an amount that you previously reported as a capital gain, deduct the repayment as a capital loss.

If you repaid social security or equivalent railroad retirement benefits, get Publication 915.

Repayment--$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 repaid an amount that you reported as wages, unemployment compensation, or other nonbusiness ordinary income, enter it on line 22 of Schedule A (Form 1040). If you repaid an amount that you reported as a capital gain, deduct it on Schedule D (Form 1040).

Repayment--over $3,000. If the amount you repaid was more than $3,000, you can deduct the repayment, as described 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 2000 claiming a deduction for the repaid amount.

Method 2. Figure your tax for 2000 claiming a credit for the prepaid amount. Follow these steps.

1. Figure your tax for 2000 without deducting the repaid amount.
2. Refigure your tax from the earlier year without including in income the amount you repaid in 2000.
3. Subtract the tax in (2) from the tax shown on your return for the earlier year. This is the credit.
4. Subtract the answer in (3) from the tax for 2000 figured without the deduction (step 1).

If method 1 results in less tax, deduct the amount repaid on the same form or schedule on which you previously reported it. For example, if you reported it as self-employment income, deduct it as a business deduction on Schedule C or Schedule C-EZ (Form 1040). If you reported it as wages, deduct it as an itemized deduction on line 27 of Schedule A (Form 1040).

If method 2 results in less tax, claim the credit on line 64 of Form 1040, and write "I.R.C. 1341" next to line 64.

Example. For 1999 you filed a return and reported your income on the cash method. In 2000 you repaid $5,000 included in your 1999 income under a claim of right. Your filing status in 2000 and 1999 is single. Your income and tax for both years are as follows:

	1999 With Income		1999 Without Income
Taxable Income	$15,000		$10,000
Tax	$ 2,254		$ 1,504
	2000 Without Deduction		2000 With Deduction
Taxable Income	$49,950		$44,950
Tax	$10,581		$ 9,181

Your tax under method 1 is $9,181. Your tax under method 2 is $9,831, figured as follows:

Tax previously determined for 1999		$2,254
Less: Tax as refigured		- 1,504
Decrease in 1999 tax		$750
Regular tax liability for 2000		$10,581
Less: Decrease in 1999 tax		- 750
Refigured tax for 2000		$9,831

Because you pay less tax using method 1, you should take a deduction for the repayment in 2000.

Repayment rules do not apply. This discussion does not apply to:

1. Deductions for bad debts,
2. Deductions from sales to customers, such as returns and allowances, and similar items, or
3. Deductions for legal and other expenses of contesting the repayment.

Year payment deducted. If you use the cash method, you can take the deduction for the tax year in which you actually make the repayment. If you use any other accounting method, you can deduct the repayment only for the tax year in which it is a proper deduction under your accounting method. For example, if you use an accrual method, you are entitled to the deduction in the tax year in which the obligation for the repayment accrues.

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