Legal Definitions - claim-of-right doctrine

Claim-of-Right Doctrine

In tax law, the claim-of-right doctrine is a principle stating that if an individual or entity receives income that they believe they have a right to, they must report that income for tax purposes in the year it was received. This holds true even if there is a possibility that they might have to return the money later, for instance, due to a dispute or an error. The crucial factor is that the recipient had an apparent right to the funds at the time of receipt.

Here are a few examples to illustrate this doctrine:

• Example 1: Disputed Bonus Payment

  Imagine a sales executive, Sarah, who receives a year-end bonus of $50,000 from her company in December. Three months later, in the new tax year, the company's accounting department discovers a calculation error and informs Sarah that her bonus should have been $40,000, requesting the $10,000 overpayment back.

  How this illustrates the doctrine: Under the claim-of-right doctrine, Sarah must report the entire $50,000 as income on her tax return for the year she received it. Even though she might have to return $10,000 later, at the time she received the bonus, she had a "claim of right" to the full amount. If she repays the $10,000 in the subsequent year, she may be able to claim a deduction or credit on her tax return for that later year, but the initial receipt is fully taxable.

• Example 2: Advance Payment for Cancelled Services

  Consider David, a freelance graphic designer, who receives a $5,000 advance payment from a new client for a large design project. A week after receiving the payment, the client decides to cancel the project entirely due to a change in business strategy and requests a full refund of the advance.

  How this illustrates the doctrine: When David received the $5,000, he did so with the belief that he had a right to it as an advance for services he would perform. Despite the project's cancellation and the likelihood that he will have to return the money, the claim-of-right doctrine dictates that he must report the $5,000 as income in the year it was received. If he refunds the money in a later tax year, he can then address the repayment on that year's tax return, potentially by claiming a deduction.