In 1944, Lewis received a $22k
bonus from his employer. When he filed his 1944 tax returns, he counted
the $22k as part of his gross income.
Later, it was determined that
the bonus had been improperly calculated and a court made him return $11k
in 1946.
Lewis attempted to amend his
1944 tax returns to recalculate his gross income so as to not include the $11k he eventually
gave back. The IRS disagreed.
The IRS argued that the $11k
he gave back should be counted as a loss on Lewis' 1946 returns, not as
an amendment to his 1944 tax returns.
The Trial Court found for
Lewis. The IRS appealed.
The Trial Court found that
the excess bonus was a mistake of fact and was therefore not income in 1944.
The US Supreme Court reversed.
The US Supreme Court found
under the claim of right doctrine,
the entire $22k was income in 1944, and should be taxed as such.
Under the claim of right
doctrine if a taxpayer receives
income and there are no restrictions on its dispositions (aka they can
do whatever they want with it), then they are considered to have earned
that income, even if it is later decided that they have to give the
money back.
See North American Oil
v. Burnet (286 U. S. 417 (1932)).
In this case, Lewis received
the money in 1944 and had full enjoyment of it until he had to give it
back in 1946, so he had to pay tax on the income in 1944.
The problem for people like
Lewis is that they may be in a high tax bracket in the year they get the
money and in a lower tax bracket in the year when they get the claim the
loss. So the taxpayer is not in the same position as they would have been
if there had not been a mistake.
After this case was decided,
Congress passed 26 U.S.C. §1341,
which allows taxpayers in Lewis' situation to either take a
deduction in the year the money gets repaid, or take a tax credit equal to the amount of taxes
the taxpayer originally paid.
