Contributed by: LynR, FreeTaxUSA Agent, Tax Pro
What is the claim of right credit?
When you’ve had taxable income in a prior year that you’re required to repay in the current year, you can either take an itemized tax deduction or claim a credit on your tax return to recoup the taxes paid previously on that income. This isn't a common occurrence, but occasionally social security benefits, unemployment compensation, employer-provided sick pay, or other benefits may have to be repaid in a later year than they were originally taxed. To be eligible for the deduction or credit, the amount repaid must be $3,000 or greater. If it's less, no deduction/credit is allowed.
Claim of right itemized deduction
If you choose to take an itemized deduction for the tax previously paid, you'll enter the amount of income you're required to repay during the year on the Miscellaneous Itemized Deduction screen. Follow the menu path: Deductions/Credits > Itemized Deductions > Other Itemized Deductions.
On this screen, select Claim Repayment from the dropdown menu and enter the amount of income repaid.
This will apply an itemized deduction for the same amount of the income repaid.
Claim of right credit
In many cases, the claim of right credit is more beneficial than the claim of right deduction.
The claim of right credit is a dollar-for-dollar credit for the tax paid on income that was reported in a prior year but later repaid. However, calculating the credit requires more effort than entering the deduction.
Calculating the claim of right credit
If you used FreeTaxUSA to prepare your prior year tax return when the repaid income was originally taxed, calculating the credit is fast and easy.
First, sign into your prior year account. One way to access a prior year account is to select the Prior Year option from the FreeTaxUSA homepage. Select the desired year and sign into that year’s software.
Once signed into the prior year account, click on the menu option to amend the tax return. While you won’t actually file the amended return to claim this credit, using the amendment process helps calculate the claim of right credit more easily.
The beginning of the amendment process asks about the refund or tax due as calculated on the original tax return. Enter the recommended overpayment or tax paid amounts provided by the software for both federal and state (if a state return was originally filed).
After completing the initial amendment information screens, navigate to the Income section to adjust the income originally entered and subtract the amount repaid.
Let’s walk through an example to see how this process works.
George received a $3,200 signing bonus from his employer in 2023. George left the company within 12 months of his hire date, violating the terms of his original contract. He was required to repay the bonus in 2024. The bonus was originally included in George’s wages and reported on his 2023, Form W-2. George’s total W-2 income was $62,200 ($3,200 signing bonus and $59,000 wages). George will calculate his claim of right credit by editing his W-2 entry. He’ll deduct $3,200 from his wages in box 1 and box 16 (if applicable).
George follows menu path: Income > Common Income > Wages (W-2).
He reduces box 1 and 16 from $62,200 to $59,000.
Once this change is saved, a new federal and state refund is calculated.
The updated refund represents the federal tax originally paid on the income that was later repaid.
This is the claim of right credit for the year the $3,200 was repaid. For George, the credit amount is $704.
Now that George has the claim of right credit amount, he can delete the 2023 amendment since it doesn’t need to be filed. To do this, he selects Account > Delete Amendment.
Next, George needs to access the software for the year in which the repayment occurred. He signs into his 2024 account and follows the menu path: Deductions/Credits > Other Deductions/Credits > Claim of Right Repayment Credit.
George enters $704, the refund amount calculated from the prior year amendment.
Once saved, this credit will be reported on Schedule 3, line 13b of his tax return.
What if I didn’t use FreeTaxUSA to prepare my prior year return?
Even if you used another service or provider to prepare your original return in the prior year, our software can still help you calculate your claim of right credit. Simply follow the instructions in this article.
If you’d prefer to calculate the credit on your own, here are some general instructions:
- Make sure the amount you had to repay was taxable on your prior year tax return. To do this, view your original Form 1040. The amount needs to appear in boxes 1a-1h, 2b-6b, 7 or 8 on page 1 of Form 1040. If it does, proceed to step 2.
- Figure your new taxable income. Reduce the number on Form 1040, box 15 by the amount you repaid.
- Use the IRS tax tables found in the Instructions for Form 1040 for the corresponding tax year to figure the tax on the reduced taxable income from step 2.
- Subtract the amount from step 3 from the amount in box 16 of Form 1040 on your return for the corresponding year. This is the amount of your claim of right credit.
Note: This method is not recommended if you have long-term capital gain income reported in the year in question, since this affects the tax calculation differently than ordinary income.
Getting it right
Calculating your claim of right credit can be complicated, but FreeTaxUSA can help. Using our software to calculate your credit is accurate and will give you peace of mind regardless of whether you originally filed your prior year return with us. If you still have questions, our support team is here to assist you. The most important thing is to claim the credit or deduction you're eligible for.