In the event a taxpayer returns income they reported in a prior tax year, they may deduct the repayment as a miscellaneous itemized deduction. If the repayment of those wages exceeds $3,000 then the deduction can be claimed on Line 28 of Schedule A and is not subject to the 2% of adjusted gross income floor. If the repayment is $3,000 or less then the deduction must be claimed on Line 23 of Schedule A, where it is then subject to the 2% of adjusted gross income floor.
If the repayment exceeds $3,000, another option is to claim the repayment as a tax credit, based on a re-computation of the prior year’s tax. The credit is equal to difference between the actual tax paid in the prior year and the re-computed tax without the returned income. For example, if the actual tax paid in the prior year was $25,000 and the re-computed tax without the returned income was $24,000 then the taxpayer has a $1,000 credit ($25,000 minus $24,000).