From Opus 17:
Generally speaking, payments for personal injury or property damage are not taxable, but recoveries for punitive damages or lost wages/income are taxable.
There are a number of variations (like, if you deducted medical expenses in a prior year that are now paid off by the settlement, you have a report a reimbursement of a deduction, and that is taxable. Or, if you received money for your damaged car and the money is more than the car was worth, the excess is taxable). This link provided gives more examples. http://www.irs.gov/pub/irs-pdf/p4345.pdf
Your attorney costs are deductible, but only as far as the damages are taxable (if 50% of your damages are taxable, then 50% of your fees are deductible). And they are a miscellaneous deduction subject to the 2% rule, so you may or may not actually benefit from claiming the deduction.
In a perfect world, you would receive a 1099-Misc from the payer that only lists the taxable part (wages and such).
You can also report it as other income on Form 1040 line 21 AND make a second entry for the same amount as a negative to negate the first entry. Here's how to enter it in TurboTax.
· Click the Federal Taxes tab.
· Click Wages & Income.
· Click "I'll choose what I work on."
· On the screen "Your 2014 Income Summary," scroll all the way down to the last section, "Less Common Income."
· Click the Start or Update button for the last topic, "Miscellaneous Income, 1099-A, 1099-C."
· On the next screen, "Let's Work on Any Miscellaneous Income," scroll down and click the Start or Update button for the last topic, "Other reportable income."
· The next screen asks, "Did you receive any other taxable income." Click Yes.
· On the next screen, "Other Taxable Income," enter a description and the amount. Click Continue.
· On the next screen click Done.
The income will be reported on Form 1040 line 21 with the description that you entered.
I have a situation like this, received a 1099 MISC for an employment discrimination lawsuit settlement from which I'm entitled to deduct attorneys fees. I followed your example below, but do not see the part you mention about the second negative entry. When I input this into other reportable income on TurboTax, it specifically admonishes me NOT to enter anything for which I received a 1099. Can you enlighten me? Thanks so much.