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ejorda12
Level 1

How do I enter the amount for a lawsuit settlement, for out of pocket legal fees, reported on a 1099-NEC to avoid being taxed?

I received a settlement from a discrimination lawsuit in 2020 from a former employer.  The monetary portion of the settlement was for reimbursement for my out of pocket attorney's fees.  I received a 1099-NEC from the former employer for the full amount of the reimbursement.  Since the monetary settlement was a reimbursement of my out of pocket expenses, this should not be taxed.  How do I enter the settlement amount in Turbo Tax so it is not taxable?  When I enter it in Federal, Wages & Income, 1099-MISC and Other Common Income, and Income from Form 1099-NEC, Turbo Tax is requiring me to create a Schedule C,   even though I chose "This was money from a lawsuit settlement".  I'm looking for a way to enter the amount reported on the 1099-NEC and offset it without being taxed.

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Accepted Solutions
rjs
Level 15
Level 15

How do I enter the amount for a lawsuit settlement, for out of pocket legal fees, reported on a 1099-NEC to avoid being taxed?

Is the entire amount on the Form 1099-NEC reimbursement for attorney's fees? If so, I think they should have reported it on a 1099-MISC, not a 1099-NEC. But here's how you can enter it in TurboTax. You didn't say whether you are using TurboTax Online or the CD/Download TurboTax software. This can only be entered in the CD/Download software because it requires entries in forms mode. TurboTax Online does not have forms mode.

 

  • Click the Federal Taxes tab.
  • Click Wages & Income.
  • On the screen "Your 2020 Income Summary" scroll down to the section "1099-MISC and Other Common Income." Click the Start button for "Income from Form 1099-NEC."
  • Did you get a 1099-NEC? - Click Yes.
  • Do You Want to Enter Your 1099-NECs Now? - Click "Add a 1099-NEC."
  • Enter the payer's name and federal ID number, and the amount of the payment in box 1. Click Continue.
  • Describe the reason for this 1099-NEC - Enter a short description, such as "Attorney fees" or "Lawsuit settlement." The description that you enter will not appear on your tax return. Click Continue.
  • Does one of these uncommon situations apply? - Select "This was money from a lawsuit settlement."
  • Was any part of the lawsuit settlement for back wages? - Select No. Click Continue.
  • On the next screen, "1099-NEC Summary," click Done.
  • The next screen says "Looks like we're missing some info." Click Continue.
  • The next screen says that the 1099-NEC will be deleted. Click No. This returns you to "Your 2020 Income Summary." The 1099-NEC has not been deleted.
  • Click the Forms icon at the top to switch to forms mode.
  • In the list of forms on the left, there will be a red exclamation point next to the 1099-NEC Worksheet, and it will say "Not Done." Open the 1099-NEC Worksheet if it has not appeared automatically.
  • In box 1 of the Form 1099-NEC Worksheet, the Schedule C line will be shaded pink. A few lines below that, still in box 1, click the Other Income checkbox. The pink shading, the red exclamation point, and the "Not Done" will all disappear.

Now open the "Form 1040 or Form 1040-SR Worksheet" (1040/1040SR Wks). Scroll down to the Schedule 1 section (Additional Income and Adjustments to Income), then to Part II Adjustments to Income, and then to the Other Adjustments to Income Smart Worksheet between lines 21 and 22. The attorney fees are entered on line H of the Smart Worksheet. In the text entry box on the left side, right after the H, enter UDC. Enter the amount in the space on the right. The letters UDC and the amount will then appear on the dotted line to the left of the amount on line 22, and the fees will be added to any other amount that was already on line 22. The same notation, UDC and the amount, will appear on line 22 on Schedule 1.


The amount from the 1099-NEC will be reported as other income on Schedule 1 line 8, and it will be entered as an adjustment (i.e. a deduction) on Schedule 1 line 22. The net result is that it is not included in your Adjusted Gross Income (AGI) on Form 1040 line 11, so you do not pay tax on it.

 

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3 Replies
rjs
Level 15
Level 15

How do I enter the amount for a lawsuit settlement, for out of pocket legal fees, reported on a 1099-NEC to avoid being taxed?

Is the entire amount on the Form 1099-NEC reimbursement for attorney's fees? If so, I think they should have reported it on a 1099-MISC, not a 1099-NEC. But here's how you can enter it in TurboTax. You didn't say whether you are using TurboTax Online or the CD/Download TurboTax software. This can only be entered in the CD/Download software because it requires entries in forms mode. TurboTax Online does not have forms mode.

 

  • Click the Federal Taxes tab.
  • Click Wages & Income.
  • On the screen "Your 2020 Income Summary" scroll down to the section "1099-MISC and Other Common Income." Click the Start button for "Income from Form 1099-NEC."
  • Did you get a 1099-NEC? - Click Yes.
  • Do You Want to Enter Your 1099-NECs Now? - Click "Add a 1099-NEC."
  • Enter the payer's name and federal ID number, and the amount of the payment in box 1. Click Continue.
  • Describe the reason for this 1099-NEC - Enter a short description, such as "Attorney fees" or "Lawsuit settlement." The description that you enter will not appear on your tax return. Click Continue.
  • Does one of these uncommon situations apply? - Select "This was money from a lawsuit settlement."
  • Was any part of the lawsuit settlement for back wages? - Select No. Click Continue.
  • On the next screen, "1099-NEC Summary," click Done.
  • The next screen says "Looks like we're missing some info." Click Continue.
  • The next screen says that the 1099-NEC will be deleted. Click No. This returns you to "Your 2020 Income Summary." The 1099-NEC has not been deleted.
  • Click the Forms icon at the top to switch to forms mode.
  • In the list of forms on the left, there will be a red exclamation point next to the 1099-NEC Worksheet, and it will say "Not Done." Open the 1099-NEC Worksheet if it has not appeared automatically.
  • In box 1 of the Form 1099-NEC Worksheet, the Schedule C line will be shaded pink. A few lines below that, still in box 1, click the Other Income checkbox. The pink shading, the red exclamation point, and the "Not Done" will all disappear.

Now open the "Form 1040 or Form 1040-SR Worksheet" (1040/1040SR Wks). Scroll down to the Schedule 1 section (Additional Income and Adjustments to Income), then to Part II Adjustments to Income, and then to the Other Adjustments to Income Smart Worksheet between lines 21 and 22. The attorney fees are entered on line H of the Smart Worksheet. In the text entry box on the left side, right after the H, enter UDC. Enter the amount in the space on the right. The letters UDC and the amount will then appear on the dotted line to the left of the amount on line 22, and the fees will be added to any other amount that was already on line 22. The same notation, UDC and the amount, will appear on line 22 on Schedule 1.


The amount from the 1099-NEC will be reported as other income on Schedule 1 line 8, and it will be entered as an adjustment (i.e. a deduction) on Schedule 1 line 22. The net result is that it is not included in your Adjusted Gross Income (AGI) on Form 1040 line 11, so you do not pay tax on it.

 

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ejorda12
Level 1

How do I enter the amount for a lawsuit settlement, for out of pocket legal fees, reported on a 1099-NEC to avoid being taxed?

Thank you for your reply.  Yes, the entire amount on the Form 1099-NEC was a reimbursement for attorney's fees.  I am using the CD/Download TurboTax software and I was able to enter into forms mode.  I followed your very detailed instructions and the adjustment was correctly reflected in my tax return.  You're a life saver, as I could not figure this out.   

rjs
Level 15
Level 15

How do I enter the amount for a lawsuit settlement, for out of pocket legal fees, reported on a 1099-NEC to avoid being taxed?

I'm glad I could help you.


Unfortunately you will probably get a letter from the IRS saying that you should have filed Schedule C and Schedule SE, and that you owe self-employment tax on the payment. I don't think there's any way to avoid this. The letter is computer-generated when there's a 1099-NEC (over $400) and no Schedule C. No human being looks at the tax return until they get your reply to the letter. You will have to reply to the letter explaining that the payment was incorrectly reported on Form 1099-NEC instead of 1099-MISC, and that it's a lawsuit settlement for attorney's fees, not back wages.


You could try to get the company to issue a corrected 1099-NEC with a zero amount, and a 1099-MISC with the payment in box 3, but that might be more of a hassle than answering the letter from the IRS.

 

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