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inescapable that the payments constituted distributions by
Hillside Dairy to the Schmidts.
In N. Am. Oil Consol. v. Burnett, 286 U.S. 417, 424 (1932),
the Supreme Court stated:
If a taxpayer receives earnings under a claim of right
and without restriction as to its disposition, he has
received income which he is required to return, even
though it may still be claimed that he is not entitled
to retain the money, and even though he may still be
adjudged liable to restore its equivalent. * * *
It is clear, therefore, under the claim of right doctrine, the
amounts paid by Hillside Dairy in 1995, 1996, and 1997 were
taxable to the Schmidts in those years. See Pahl v.
Commissioner, 67 T.C. 286, 289 (1976).
If a taxpayer is required to repay income recognized under
the claim of right doctrine in an earlier tax year, section 1341
permits the taxpayer, in effect, to elect to compute his taxes
for the year of repayment in a manner that gives the taxpayer the
equivalent of a refund (without interest) of tax for the earlier
year. Specifically, section 1341(a)(5) permits the tax for the
year of repayment to be reduced by the amount of the tax paid for
the year of receipt that was attributable to the inclusion of the
repaid amount in that year’s gross income. United States v.
Skelly Oil Co., 394 U.S. 678, 682 (1969). Section 1341, however,
requires actual repayment, restoration, or restitution. Chernin
v. United States, 149 F.3d 805, 816 (8th Cir. 1998); Kappel v.
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