## Facts

- Van-Mark Corporation adopted a 1969 bylaw requiring officers to repay any compensation the IRS later determined to be “excessive” and nondeductible to the corporation.
- Eugene Van Cleave, Van-Mark’s president and majority shareholder, also executed a separate agreement obligating him to reimburse the corporation for nondeductible compensation.
- In 1974, Van Cleave received $332,000 in salary and bonuses and reported the full amount as income on his individual return.
- After a 1975 audit of Van-Mark, the IRS disallowed $57,500 of Van Cleave’s 1974 compensation as an excessive, nondeductible corporate expense.
- In December 1975, pursuant to the bylaw and repayment agreement, Van Cleave repaid $57,500 to Van-Mark.
- On his 1975 return, Van Cleave sought relief under 26 U.S.C. § 1341 to obtain the statute’s favorable tax recomputation mechanism rather than only a repayment-year deduction.
- The government conceded Van Cleave could deduct the $57,500 in 1975 but denied § 1341 treatment.

## Issues

1. Whether a taxpayer who reported compensation as income in the year received, then repaid a portion under a preexisting obligation after an IRS determination of “excessive” compensation, qualifies for claim-of-right tax recomputation under 26 U.S.C. § 1341.
2. Whether § 1341’s “appeared ... unrestricted right” requirement is satisfied when the taxpayer’s repayment duty exists before receipt, but the amount to be repaid becomes fixed only after a later IRS determination.

## Decision

- The Sixth Circuit reversed the district court’s judgment for the government and remanded.
- The court held Van Cleave was entitled to the benefit of 26 U.S.C. § 1341 for the $57,500 repayment.
- The court rejected the government’s view that § 1341 was unavailable because any restriction on Van Cleave’s right to the compensation arose only after the IRS audit and determination.

## Legal Principles

- Section 1341 applies when an item was included in gross income in a prior year because it appeared the taxpayer had an unrestricted right to it, and it is later established that the taxpayer did not have that unrestricted right, permitting a tax reduction in the repayment year via the statute’s recomputation method (subject to statutory thresholds).
- The “unrestricted right” inquiry under § 1341 turns on the appearance at the time of inclusion and a later establishment of lack of entitlement; § 1341 is not defeated merely because the event establishing nonentitlement occurs after the close of the prior tax year.
- A repayment compelled by a binding, preexisting bylaw/contractual obligation, triggered and quantified by a later IRS determination, can satisfy § 1341’s requirement that the taxpayer is later established not to have had an unrestricted right to the repaid portion.
- A taxpayer qualifying under § 1341 may reduce repayment-year tax by the greater of (1) the tax savings from the repayment-year deduction or (2) the decrease in prior-year tax that would have resulted from excluding the repaid item from prior-year income.

## Conclusion

The Sixth Circuit held that a taxpayer who reported compensation under an apparent claim of right and later repaid a portion under a preexisting repayment obligation after an IRS excess-compensation determination could use 26 U.S.C. § 1341’s claim-of-right recomputation, not merely a deduction in the year of repayment.


Van Cleave v. United States, 718 F.2d 193 (6th Cir. 1983)