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Military Finances 401: Claim of Right Doctrine

Taxes

I’ve worked with a fair number of retired military officers who received a signing bonus when they started their new career. Many of those signing bonuses require that the retiree stays in the job for a certain period of time. Usually to keep the bonus the retiree will need to hang around for a year or more. But what happens if you don’t hang around for the required amount of time? And more importantly, what happens if you leave in a different year than when you received the bonus?

Repaying the Bonus in the Year Received

The first part is pretty simple. If you don’t stay around for the required time, you’ll need to pay back the bonus. Hopefully, you haven’t spent it all. If you pay back the bonus in the same year you received it, there shouldn’t be any tax issues. Your W-2 should reflect the fact that the bonus was paid back. If you leave and pay back the bonus in a different year than you received it, you have a bit of a tax concern.

Repaying the Bonus in a Later Year

When you receive the bonus, the income is taxable and you pay taxes on it. Since you’re paying the bonus back you need to reconcile the taxes due. It might be tempting to file an amended return for the year you received the bonus. Avoid that temptation. Instead you will adjust your return for the year you paid back the bonus using the Claim of Right Doctrine.

Using the Claim of Right Doctrine as codified by the Congress, you have the option of calculating your repayment year taxes two different ways.

  • Taking a deduction for the amount of the repayment. This is a miscellaneous itemized deduction not subject to the 2% floor, so the Tax Cuts and Jobs Act did not affect it.
  • Calculate how much lower your taxes would have been in the year you received the bonus and take the difference in the taxes owed as a credit in the year you repaid the bonus.

You can elect the method that lowers your tax bill the most.

There is one restriction.  The deduction must exceed $3,000.

Taxes Are a Lot More Complicated After Military Retirement

Our taxes are pretty simple while we’re on Active Duty. When we enter a post-military career, they get a lot more complicated. We spend virtually every day working on these tax issues for our retired military clients. If you’d like some help, let us know.


If you liked this article, you might enjoy the following blog posts:

Retired Military Finances 401: Restricted Stock Units


Retired Military Finances 401: Non-Qualified Stock Options


Retired Military Finances 201: 1031 Exchanges





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