The simple answer is to report it as a taxable recovery. That is another term for a reimbursement of a previous deduction. The recovery is taxable up to the extent that you received a tax benefit from it.
For example, if we suppose that you are married and you made a $30,000 gift and you had no other itemized deductions; and you received a refund of $20,000; only $6000 is a taxable recovery, because if your itemized deductions were less than $24,000 you could have taken the $24,000 standard deduction. So the tax benefit was only $6000. On the other hand, if we suppose you donated $50,000 and received a $10,000 refund, then your itemized deductions are still well above the limitation and you received the full tax benefit of the $10,000 donation, making the full $10,000 a taxable recovery.
Taxable recoveries are entered on the “other income” or “uncommon income” section. If you are filing online and don’t see it, you may need to click some thing that says show me more choices or let me choose what I will work on.
As to the question of whether the IRS would call shenanigans on the whole relationship, that is something you would need competent legal help to advise you on. An argument could possibly be made that if you placed too many restrictions on your gift in the first place, then it wasn’t a true gift and shouldn’t have been deducted at all. But I am not an attorney and I do not have any direct knowledge that could assist you here. You should certainly report the taxable recovery, and save your documentation surrounding the gift and its return in case of an IRS audit later on.
*Answers are correct to the best of my ability at the time of posting but do not constitute legal or tax advice.*
Yes
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