Tax TARP Needed for Year One and Year Two Returns of Executive Bonus to TARP Recipient: A Case Study of Year One Rescission/Exclusion From Income and Year Two Deduction Under Section 1341

Abstract

This Article addresses the tax consequences to AIG Financial employees who repay their controversial retention bonuses in the year of receipt (Year 1) or in a subsequent year (Year 2). At the time the executives received their bonuses, the media and members of Congress raised challenges that might induce such repayment, thus justifying favorable tax treatment for repaying executives. Accordingly, bonuses repaid in year I should be excluded from gross income under the doctrine of Year 1 rescission. Bonuses repaid in Year 2 should result in an adjustment under Section 1341, which reduces the income taxes for Year 2 by the amount that the income taxes for Year I would have been reduced if the repaid bonus hypothetically had been excluded from income in Year 1. This analysis is based upon a balancing-entry approach which backs out a Year 1 transaction when an assumption at the time of Year 1 receipt (that the employee would get to keep the bonus) later turns out to have been in error. This balancing-entry approach is traced across a number of case law and statutory doctrines including the claim of right doctrine, the Crane-Tufts doctrine, and rescission and cancellation in Year 1. Contrary interpretations exist, however, manifesting the need for Congressional or administrative clarification so as to encourage repayments of such controversial bonuses