## Facts

- McKinney worked for the Texas Employment Commission.
- Beginning in 1956, McKinney planned to take money from the Commission.
- In 1966, McKinney embezzled approximately $92,000 from the Commission.
- McKinney reported the $92,000 on his 1966 federal income tax return as “miscellaneous income” and paid tax on it.
- In 1969, McKinney was convicted of embezzlement and repaid the Commission the amount taken.
- After repaying the money, McKinney sought federal tax relief, claiming the repayment qualified for I.R.C. § 1341 (claim-of-right) treatment because he had included the amount in income when received.

## Issues

1. Whether I.R.C. § 1341 applies when a taxpayer repays money previously included in income but originally obtained through embezzlement.
2. Whether embezzled funds can satisfy § 1341’s requirement that the item was included in income in a prior year because it appeared the taxpayer had an unrestricted right to the item.

## Decision

- The court ruled for the United States and denied McKinney’s refund claim.
- The court held that § 1341 did not apply because embezzled funds are not received under an apparent unrestricted right; an embezzler knows the funds belong to another.
- Because § 1341 was unavailable, McKinney could not use the statute’s recomputation/credit mechanism based on the prior-year inclusion.

## Legal Principles

- I.R.C. § 1341 is available only if (1) the taxpayer included an item in gross income for a prior year because it appeared the taxpayer had an unrestricted right to it, and (2) the taxpayer later must restore the item after it is established the taxpayer did not have that right.
- A taxpayer who embezzles funds does not, and cannot reasonably, appear to have an unrestricted right to the funds at the time of receipt because the taking is knowingly wrongful.
- Including illegal proceeds in income does not convert a wrongful taking into a receipt under a claim of right for § 1341 purposes.
- When § 1341 does not apply, any tax effect of repayment must be determined under other Code provisions governing deductions or losses, not under § 1341’s special tax computation rules.

## Conclusion

The court rejected McKinney’s attempt to use I.R.C. § 1341 after repaying embezzled funds, holding that an embezzler cannot meet the statute’s “apparent unrestricted right” condition even if the stolen amount was reported as income in the year received.


McKinney v. United States, 76–2 USTC ¶ 9728, 1976 WL 1151 (1976)