§1341 Computation of tax where taxpayer restores substantial amount held under claim of right

Summary

If you included money in your income in an earlier year because you seemed to have the right to it, but later you found out you did not and you get a deduction of more than $3,000, you can choose the tax result that makes your tax bill smaller. You may either take the deduction on this year’s tax return, or compute your tax as if you did not take the deduction and instead reduce your prior year’s tax by the amount it would have fallen if that money had never been counted as income. Pick the option that gives the lower tax. If the prior-year reduction is bigger than your tax this year, the extra is treated as a tax payment made on the last day to pay this year’s tax and will be refunded or credited like an overpayment. This rule does not apply to income from selling inventory or items held for sale in the normal course of business (except certain required refunds by regulated public utilities). If you use the prior-year method, you cannot use the current-year deduction for other tax rules. Any related net operating losses or capital losses are handled under the normal carryback and carryover rules in sections 172 and 1212, with the limits the law describes.