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How should I report a reimbursement of a wage overpayment?

by Loella Haskew 

My company overpaid me by more than $7,000 for 2001. In 2002, I reimbursed the company for the overpayment. The company gave me a credit memo and said I should use it with my 2002 tax return. But I don't know how to do this. How should I report the reimbursement?

The easiest way to handle this situation is to have your employer issue a corrected W-2 for the year 2001. You would then amend your 2001 tax return to reflect the correct wages. Incidentally, you are also entitled to reimbursement of the amounts deducted for your Social Security and Medicare taxes for that year because of the overpayment. (Your employer should reimburse you for overpayments to Social Security and Medicare if he or she hasn't done so already.) You will also need to file an amended return for your state income tax in order to be reimbursed by your state.

If your employer will not revise the W-2, then the situation you describe is covered under what are known as "claim of right" rules. The rules apply if an item was included in gross income in error. You can take a deduction for the repayment of the item if the amount of the deduction exceeds $3,000, which it does in your case.

You will now need to do some computations to see which of two alternatives results in a greater refund for you. First, you will need to compute your 2002 tax twice-once without deducting the $7,000 you reimbursed your employer and once with deducting the $7,000 on Line 21 (other income). Then you recompute your 2001 tax return without the $7,000. If you save more tax by taking the deduction in 2002, then your job is done. You just file the 2002 return.

If, however, you save more tax by recalculating the 2001 tax return, you report the "tax saving" as an estimated tax payment made on the last day of the year (on Line 62 of the 2002 form 1040). You would need to attach an explanation of the calculation, the reason for the credit, and the calculation itself to the tax return. You will need to do similar calculations for state income taxes. You may want to seek the help of a local CPA with these calculations.

Loella Haskew is a Walnut Creek, Calif., CPA with the firm of Buckley Patchen Riemann & Hall. You can reach her at (925) 937-2727(925) 937-2727.

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