Bonus Repayment Gets Messy

Every once in a while, a military member receives a bonus and then has to repay it, usually because they didn’t fulfill the terms of the bonus agreement.  And because taxes have already been taken out of that bonus payment, things can get a bit messy.

Now, if the payment and the repayment occur in the same tax year, you should be good to go.  As long as you ensure that your W-2 reflects the right amount of income and taxes withheld, the taxes that were withheld from the bonus payment will be factored into your overall return and will either result in a larger refund or a smaller amount owed.

However, if the bonus payment and the repayment occur in different years, things aren’t so simple.  A reader wrote in with this question:

“The California National Guard needed qualified MPs for a deployment to Iraq in 2009 and gave a $10,000 bonus for qualified officers to leave the Reserves and join the CA ARNG. I served two years in Iraq and then came home in 2011 to find out the CA ARNG did not have the correct paperwork and I was required to pay back the bonus. Here is the rub….They took $3000 dollars out for taxes but I had to pay back the full $10,000. How do I get that $3,000 dollars back? The CA ARNG says it is not their problem, I have to work with the IRS. This does not sit well with me as THEY took out that money! Your thoughts?”

Here’s my reply:
“When the CA ARNG withheld the $3,000 from your bonus, they submitted it to the IRS.  Both the bonus and the withheld taxes were reported to you on your W-2 for the year in which the bonus was paid.  The bonus amount and the withholding amount were reflected on your federal income tax return for that year.

Because you have repaid that bonus, you need to note this on your federal tax return for the year in which the repayment occurred.  Due to the amount, you have a slightly complicated situation.  It is explained on page 34 of IRS Publication 525.  This is tricky stuff, and if you are not comfortable with it, you should have a tax professional help you with the process.”

In a perfect world, I would just cut and paste the relevant section of IRS Publication 525.  However, this is the IRS we’re talking about.  There are all sorts of different rules depending on the amount, the type of income it was originally reported as being, and the circumstances of the repayment.  So, as I said to my reader:  if you don’t understand , get help!

If you have experience with this, or questions, please ask in the comments!

About the Author

Kate Horrell
Kate Horrell is a military financial coach, mom of four teens, and Navy spouse. She has a background in taxes and mortgage banking, and a trove of experience helping other military families with their money. Follow her on twitter @realKateHorrell.
  • Dennis

    I received a $30,000 separation pay in 1989. Of that $24,000 came to me and $6,000 was withheld as tax. I subsequently re enlisted and served to complete a 20 year retirement. On retiring, my retired pay was recouped for the entire $30,000. This took 2 1/2 years of receiving partial pay. I called the IRS and got their advice on how to handle the repayment. That worked for two years, but on the third year, the IRS took exception with the method being used. I received a phone call from the IRS and I explained that I had used their method for two years. That, they told me, opened up the returns from those two years. After visiting a local IRS office, contacting my Senator and Representative, I received an appointment with an IRS lawyer. I layed out the particulars and explained to him that they were trying to collect more than I received. At the end of an hour and a half, he turned over the sheet of paper on his desk with his finding against me. The final result with penalties and interest was that I received a $24,000 four year loan that I paid $42,000 for; $30,000 to the U.S. Army and $12,000 to the IRS. I would have done better going to a payday loan company.