treatment of legal settlement for lost retirement benefits reported on 1099-MISC

[W0X0F]

I received a settlement check from an age discrimination lawsuit for lost retirement benefits. The lawyer reported the settlement on form 1099-MISC. The cash was directly rolled into my IRA.  What is the proper way to report and file?

[RaifH · Accepted solution]

This is taxable income that would be reported as Other Income as long as the settlement did not involve wages or back pay. To report this in TurboTax:

1. Open or continue your return
2. Select the magnifying glass and search for 1099-misc. Select the Jump-to link
3. Answer Yes to Did you get a 1099-MISC?
4. Enter the info from your form into the corresponding boxes
5. Enter Lawsuit Settlement under Describe the reason for this 1099-MISC
6. Select This was money from a lawsuit settlement under Does one of these uncommon situations apply?
7. Answer No. to Was any part of the lawsuit settlement for back wages?

You will then want to report your IRA contribution in a different section. If this is a traditional IRA and you are within the income limits, this will deduct the same amount from your taxable income and will be a wash. To enter this:

1. Go to the Federal > Deductions & Credits > Retirement and Investments > Traditional and Roth IRA Contributions
2. Continue through the interview

[jetsetter8]

I have the same problems. I received a legal settlement for lost retirement benefits reported on 1099-MISC. I immediately put it into an annuity, without even cashing the check. I can enter the 1099-MISC just fine, but when I go to the Traditional and Roth IRA Contributions section under Deductions and Credits, it gives me error messages because the amount of the settlement (48k) exceeds the allowable. It's also telling me that I'll have to pay a 6% penalty every year that this money remains in the annuity. What do I do?

[AnnetteB6]

Putting your settlement into an annuity is not the same thing as putting it into an IRA. 

You should verify with your financial advisor that your money was not put into an IRA and remove the information that you entered into your tax return with regard to IRA contributions.  

Your settlement will still be entered as taxable income reported on Form 1099-MISC, but not entered as an IRA contribution.

Take a look at the following article for some information about the differences between an IRA and an annuity:

IRA vs. Annuity: What's the Difference?

@jetsetter8

[jetsetter8]

Thanks. That helped. For some reason I guess I just thought they were the same thing. It is an annuity, not an IRA.

So, if the IRA section isn't the right place to show this money was rolled into a retirement account, how/where do I show this?

[RobertB4444]

An annuity isn't a tax favored retirement account.  It's like a savings account that pays you a regular check.  You don't report that to the IRS at all - it's none of their business.

[jetsetter8]

But if I don't tell the IRS that I rolled the legal settlement check into a retirement account, they're going to consider the entire amount as income which will be taxed (a LOT of money, at least to me), plus I'll end up paying penalties for not paying estimated taxes on this check, plus, a 10% penalty for using retirement funds before age 59 1/2, won't I?

[DianeW777]

Unfortunately, the IRS will not allow a deduction into an annuity from a legal settlement. The entire amount is income for tax purposes.  The Form 1099-MISC will not be recorded as a retirement distribution on the tax return and therefore the ten percent penalty will not apply.

There are options if you have a balance due you are unable to pay in full. You are allowed to file a Form 9465 later if you want to request an installment agreement. Or you have time to make a plan to pay it in full by April to avoid any late payment penalties.

• Apply Online for a Payment Agreement

Enter your legal settlement by following the steps in the article below.

• Where do I enter the award for a taxable legal settlement?