Which Year to Report

IRC Section 1341 appears to be the correct tool for dealing with this, as described at the following August 2022 site and many other sites:

I guess the employer and employee are going to do what they're going to do here. I would suppose any penalty would be related to tax fraud. Then again and as you point out, the bottom line of these two approaches may be exactly the same.

Given the effort required for the IRS to pursue this "fraud" (if the IRS can even detect it through non-extraordinary means), I have doubts the IRS would notice.

I guess the biggest flag might appear if the employer's books were reviewed.

But why not do it the right way and sleep better at night?

Thanks for the information. It occurred to me that it's really not a situation where there would be no change. The employee would be taxed in 2022 and get a deduction in 2023. So failing to include that money in his W-2 would very likely cause him to not report taxable income that tax had already been withheld from. So he'd ask for a refund that was not due to him - based on the mistaken actions of the employer.

I don't know why they'd be so insistent on not including that money in his W-2 and just treating the whole thing like it never happened, since they already withheld taxes on the money. Would the W-2 not be consistent with the quarterly estimated tax reports? If so, that could cause a big problem.

Section 1341 requires "an item was included in gross income for a prior taxable year (or years) because it appeared that the taxpayer had an unrestricted right to such item"

In this case, it seems the item did not have an unrestricted right to such item.

Seems the payment in 2022 was a loan, to be forgiven if the terms were met.

Having to pay money back, by itself, doesn't mean the person doesn't have an unrestricted right to it. If the contract were drafted so that the money was a loan, to be forgiven if the employee completed his obligations, then I'd agree with you. But in this case the employee earned the money and he had every right to keep it, as long as he performed his obligations under the contract.

If the mere possibility of having to pay money back meant it wasn't taxable, most of the money companies earn from the sale of goods wouldn't be taxable for several years after the sale, because the customer could sue to get their money back, and could even win those suits, for that period of time.

adding back the OP from Mr. Bronstein:

An employer paid a new employee a signing bonus in 2022 (withholding all necessary taxes). The employee didn't last to fulfill his commitment, so paid back the bonus in 2023. The employer just wants to net everything and not include the $10,000 on the employee's W-2 for

2022. I advised against it, and they asked what the penalty would be if they did what they propose.

As far as I'm aware, since there would apparently be no taxes due (in theory - I'm still not so certain) would there be a penalty for that?

Thanks for any thoughts.

Bonuses paid to a new hire come with an unrestricted right in every case I have ever seen. Employers do not pay the amount and restrict the employee's use. The employer assumes that the money is gone and will never be paid back. Therefore, if the contract is violated and the bonus is paid back in the next year then the employee can use the deduction method or the credit method if the repayment is in excess of $3000. And... if upon request the employer refuses to refund the social security and medicare taxes that were withheld, the employee can request a refund on IRS Form 843.

Thanks Alan. That was my thought too, but I wanted to check with people who had more experience on this point than I do.