Taxpayers who had to repay an amount that was included in their income in an earlier year, may be able to deduct the amount repaid from their income for the year in which they repaid it. If the amount repaid is more than $3,000, they may be able to take a credit against their tax for the year in which they repaid it. In most cases, a deduction or credit can be claimed only if the repayment qualifies as an expense or loss incurred in trade or business or in a for-profit transaction.
Type of deduction. The type of deduction allowed in the year of repayment depends on the type of income included in the earlier year. In most cases, deduct the repayment on the same form or schedule on which it was previously reported it as income. For example, if it was reported as self-employment income, deduct it as a business expense on Schedule C (Form 1040) or Schedule C-EZ (Form 1040) or Schedule F (Form 1040). If the income was reported as a capital gain, deduct it as a capital loss as explained in the Instructions for Schedule D (Form 1040). If the income was reported as wages, unemployment compensation, or other non-business income, deduct it as a miscellaneous itemized deduction on Schedule A (Form 1040), and see the instructions there.
If the income repaid was social security or equivalent railroad retirement benefits, see Pub. 915.
Repayment of $3,000 or less. If the amount repaid was $3,000 or less, deduct it from income as explained above in the year it was repaid.
Repayment over $3,000. If the amount repaid was more than $3,000, the amount can be deducted as explained above or a tax credit can be taken for the year of repayment if the income was included in the prior year under a claim of right. This means that at the time the income was included, it appeared that the taxpayer had an unrestricted right to it. If the taxpayer qualifies for this option, figure the tax under both methods and compare the results. Use the method (deduction or credit) that results in less tax.