I received a 1099 Misc for Compensatory Damages awarded through a Legal Settlement. How do I offset this reported income and flag it as non-taxable?

[Opus 17]

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@BTC198 wrote:

I originally thought this would have been reported on a 1099-Misc, but the instructions on that form make it seem to say that Box 3 other income is used to report taxable damages.  I think that is why they may have reported on the 1099-NEC instead?  I'd hate to have an automated notice for SE tax. Any thoughts on how else to avoid that?

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No.  Unless you want to report it as self-employment and pay the SE tax and income tax.   The IRS computers are basically set up to shoot first and ask questions later.  They will see the 1099-NEC in your file and no matching schedule SE, and that will result in an automated notice. When you reply, that will get read by an actual human being.  You should include information about the injury, any settlement documents, and any legal sources you might think support your case.  You will have to convince the examiner of two things; the income is not compensation from working (including lost wages), and it is non-taxable within the meaning of 104(a)(2).  If you only address the compensation issue and forget to address the injury issue, the examiner will likely revise your return to assess income tax.

I can't take the time to research PTSD specifically but this IRS document seems to have some useful information,

https://www.irs.gov/pub/irs-utl/lawsuitesawardssettlements.pdf

Compensation for PTSD would probably be non-taxable if the triggering event involved physical injury, but it will probably be considered taxable if the triggering event does not involve physical injury. 

https://www.law.cornell.edu/uscode/text/26/104

Good luck. 

[Hal_Al]

When you make the negative entry at Less common income, type "Non-taxable compensation under IRC section 104(A)(2)" for description.  That  is what TurboTax will show on line 8 of Schedule 1.

Line 8 will show:

Nonemployee compensation from 1099-NEC                      $XX,XXX

Non-taxable compensation under IRC section 104(A)(2)  -$XX.XXX

[BTC198]

Thank you all for your help! 

Last question, would it be better to ask the employer to report the amount on a different form so that an automatic SE tax response won't be generated? Or is it too late for that as the 1099-NEC has been filed?  If so, which form? I still the think the 1099-Misc is supposed to show the taxable amount but maybe still better than generating an automatic response?

[Opus 17]

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@BTC198 wrote:

Thank you all for your help! 

Last question, would it be better to ask the employer to report the amount on a different form so that an automatic SE tax response won't be generated? Or is it too late for that as the 1099-NEC has been filed?  If so, which form? I still the think the 1099-Misc is supposed to show the taxable amount but maybe still better than generating an automatic response?

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You could ask if the payer will cancel/rescind the 1099-NEC and issue a 1099-MISC.  They are not required to do so, especially if their tax advisors think a 1099-NEC is correct in this situation. 

[Hal_Al]

If the income is truly non taxable, a 1099, of any kind, should not have been issue. So, better than changing to a 1099-Misc, you want the employer to issue a corrected 1099-NEC showing 0 in box 1.

[Opus 17]

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@Hal_Al wrote:

If the income is truly non taxable, a 1099, of any kind, should not have been issue. So, better than changing to a 1099-Misc, you want the employer to issue a corrected 1099-NEC showing 0 in box 1.

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The taxpayer who re-started this thread, @BTC198 , received a settlement for PTSD.  It's my expectation that the former employer issued the 1099 because  the payment was more than $600, they want to be in compliance with the IRS, and its the taxpayer's responsibility to determine if the income is taxable, and not the company's responsibility.

Which position I completely understand (although we might quibble that it should have been a 1099-MISC instead of a 1099-NEC, but then again, we don't know all the facts and circumstances). 

I really think @BTC198 is over-thinking the situation and worrying needlessly.  If they have proof of what the settlement is for, they can make their case. 

[Critter-3]

An option which would achieve  the same bottom line and avoid any IRS letters would be to enter the 1099-NEC on the Sch C where the IRS computers expect to see it be reported and then enter a misc deduction for the entire amount to negate the income.  

[Opus 17]

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@Critter-3 wrote:

An option which would achieve  the same bottom line and avoid any IRS letters would be to enter the 1099-NEC on the Sch C where the IRS computers expect to see it be reported and then enter a misc deduction for the entire amount to negate the income.  

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But then you are filing a completely incorrect tax return because you are afraid of a computer.  I would not do this, and I think I need to unsubscribe and not make further comments. 

[Critter-3]

@Opus 17 

This option has been used successfully when a corrected 1099 cannot or will not be issued.  This has been discussed many times in the forum and many have agreed to this method  as long as the user knows the income is absolutely NOT taxable and the incorrect form was issued.  

[BTC198]

Thank you everyone for the very helpful input and suggestions!  I will take it all into account and decide the best course of action.