Toxic

A single question dominates my mailbox these days. What are the tax consequences of repaying PERS with a single or a small number of payments in a tax year? We've already paid taxes on the money we could be asked to repay. How do we recover the taxes we paid? As you all know, I'm not a CPA, not an accountant, and still use Turbo Tax to file my own tax returns. But I did ask the question to a CPA group to which I subscribe. One answer, which makes some degree of sense, is posted below. Needless to say, if you have a large bill, you're in for some toxic tax shock to add to the outrage of having to repay the money. What follows is NOT my writing.

"If you have to return money that you received in a prior tax year that you reported as taxable income then you have a "repayment" for which there is a defined set of rules. The IRS explains the rules starting on page 31 of IRS Pub 525.

In your case, as the repayment is in excess of $3000 you may either deduct the repayment as a Misc. Itemized Deduction Not Subject to the 2% AGI limitation (Line 27 of Schedule A) or you may compute a tax credit. The credit is a what-if computation. No amending of prior year tax returns is performed. You go back to the prior years and recompute your tax bill as if you had never received the income. You then find the difference between your actual tax bill for the prior years and the refigured tax bill. That becomes the credit. You subtract the credit from your current year taxes figured without any deduction for the repayment. You would select whichever method (deduction or credit) provides the lowest tax in the current year."

Doesn't this sound like a ton of fun?