When Can a Payment Subject to an Offsetting Obligation Be Excluded From Income?

It is not uncommon for a taxpayer to receive a payment subject to an offsetting legal obligation,
either to repay the funds under specified circumstances or to expend the funds in a manner
directed by the payor. If the transaction is not clearly documented as a loan, the taxpayer faces the question whether the payment must be included in income.

Although this issue can arise in an almost infinite variety of factual contexts, in most situations the case law resolves the tax treatment of the payment under (1) the “claim of right” doctrine, (2) the developing body of case law relating to “deposits,” or (3) “agency,” “conduit,” or “trust fund” theories. A common thread in all these lines of authority is that the treatment of the payment depends almost entirely on the nature of the obligation to return or expend the funds. Surprisingly, whether the taxpayer segregates or earns a return on the received funds does not appear to be of much signifi cance in resolving the income recognition issue.

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