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itself had an unrestricted right to the claim into an actual claim that would Reflections
funds, the court found the Heitings have stripped the trust of its unrestricted Even if there had been an actual re-
could not succeed. right to the income. striction on the sale of the stock by the
The Seventh Circuit stated that the In support of their position, the Heitings’ trust, the couple might still
“insurmountable problem” with the He- Heitings cited First National Bank of not have gotten their requested refund.
itings’ argument was that the couple did Chicago, 551 F. Supp. 157 (N.D. Ill. As the court alluded to in its decision,
not adequately show that the trust had 1982), but the Seventh Circuit deter- it would likely agree with the IRS’s ar-
a legal obligation to restore the items of mined that that case weighed against gument that a restoration, as required
income. Under Sec. 1341(a)(2), the He- the Heitings’ position. It found that in under Sec. 1341, had not occurred.
itings had to show that the repayment First National, the district court had The Heitings argued that the trust-
in the later year occurred because “it held that a trust beneficiaries’ dispute of ee’s sale and subsequent repurchase
was established after the close of such a sale by the trust was only a potential of the restricted stock falls within the
prior taxable year (or years) that the restriction, which was not a restriction language of Sec. 1341(a) as a taxable
taxpayer did not have an unrestricted on use for purposes of the claim-of- transaction that was “reversed” in the
right” to the income in question. The right analysis. The district court based year after the sale by a trustee that was
language of Sec. 1341(a)(2) has been this determination on Healy, 345 U.S. legally obligated to do so. This charac-
interpreted to mean that the taxpayer 278, 284 (1953), in which the Supreme terization of the transactions implied
is required to have a legal obligation Court stated, in a claim-of-right analy- that the purchase was a “reversal” of
to restore the income, not merely a sis, “a potential or dormant restriction the original sale and was a retraction
voluntary choice to restore it. The ... which depends upon the future of the sale, undoing it cleanly and put-
Seventh Circuit, quoting Mihelick, 927 application of rules of law to present ting the parties to the transaction in
F.3d 1138, 1146 (11th Cir. 2019), facts, is not a ‘restriction on use.’” The the same place as before it.
found that to meet that requirement, Seventh Circuit stated that the First However, the court agreed with
taxpayers must demonstrate that they National court thus had made clear that the IRS that the timing of the two
“involuntarily gave away the relevant an initial objection by a beneficiary to transactions rendered that character-
income because of some obligation, and the sale, or the limitations of the trust ization inaccurate and found that a
the obligation had a substantive nexus agreement itself, were not in themselves sale of stock in one time period cannot
to the original receipt of the income.” sufficient to demonstrate that the tax- be simply “reversed” by purchasing
The court, again citing Mihelick, stated payer did not have an unrestricted right the stock back at a different time,
that the involuntary legal obligation to the item of income. because the fluctuation in prices will
to restore the income can be shown by According to the Seventh Circuit, often result in a greater loss or gain
a court judgment requiring the repay- this was the situation in the Heitings’ over that time. Thus, the repurchase
ment or a good-faith settlement of case, as the couple, as beneficiaries, of the stock (which, in the Heitings’
a claim. had not challenged the restricted stock case, was made at lower price than
In the Seventh Circuit’s view, the sale and had merely alleged in their what the stock was sold for) could not
Heitings did not allege in their com- complaint that the sale of the restricted be viewed as a restoration under Sec.
plaint that the trust did not have an stock violated the terms of the trust 1341(a).
unrestricted right to the item of income agreement. This, the court concluded, Heiting, No. 20-1324 (7th Cir.
in this case; instead, they only alleged was “precisely the type of potential or 10/18/21) ■
that the trustee’s restricted stock sale was dormant restriction, dependent on the
contrary to the trust agreement, which, future application of law to fact, that is
at most, was a potential restriction insufficient to indicate that a right to
originating at the time of the transaction the item of income was not an unre-
in 2015. The court concluded that the stricted one” (slip op. at 10). Therefore Contributor
existence of this potential claim against the Sec. 1342(a) requirement that the
the income was not enough to “establish” taxpayer not have an unrestricted right James A. Beavers, CPA, CGMA, J.D.,
that the trust lacked an unrestricted to the income was not met, and the LL.M., is The Tax Adviser’s tax techni-
right to the income, and the Heitings, taxpayers were not entitled to a refund cal content manager. For more infor-
as sole beneficiaries of the trust, had not based on their purported restoration mation about this column, contact
demanded the restoration of the income, of the income under the claim-of- thetaxadviser@aicpa.org.
which would have turned the potential right doctrine.

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