For 1099-MISC legal settlement penalty Back Wages yes or no?

[leimann00]

We received a 1099-Misc that says it is for Penalties.

We received a W-2 for back pay.

The class action suit says it is to recover back pay.

The whole amount received is for both the W-2 amount (back pay) and the 1099-Misc (penalty).

The IRS sees the penalty as taxable because it represents a return of pay lost.

The confusion is What does turbo tax mean by back pay when this is a penalty not the back pay portion????

How do I answer this?   It is ambiguous.

So does the penalty include "back pay",  when I get a W-2 that says it is for the back pay portion?

Then even more confusion if the penalty includes back pay , how much?   all or the portion that is the W-2?

Help!

[Opus 17]

A settlement for unpaid wages is considered taxable employment income (compensation for services performed) and should be reported on a W-2, with social security and medicare tax withheld.

If a portion of the settlement is for interest, legal fees, penalties, or something that is not unpaid wages, that part of the settlement is taxable income, but it is not subject to social security and medicare withholding or self-employment tax.

Only you know if your settlement was correctly divided between wage and non-wage income.  If you think the division is wrong, you need to contact the payer.  But for the most part, it sounds like you received the right documents.  Enter them exactly as you received them.  If, after you enter the 1099-MISC, the program asks if this was wages, answer no. 

[leimann00]

Thank you!

I agree.

I don't see why you would ever answer yes unless a mistake was made and money that should have been reported on the W-2 was instead reported in the 1099-misc?

What does turbotax do when you answer yes and put an amount?

Do they then enter it to be charged social  security tax?   as if it came from a W-2?

[Opus 17]

@leimann00 

I don’t know exactly where you are in the program. In general, if you report a 1099 and check the box for “this was from my job and should have been included on my W-2“, TurboTax will prepare a substitute W-2 form and will charge you 7.65% Social Security and Medicare tax, instead of 15% self-employment tax.  The most common situation for this to occur is if an employer pays a bonus or severance and does not report it on the W-2 like they should.

[leimann00]

That's good to know.

This is in the 1099-Misc part of Turbotax where legal settlement is checked.   A question then pops up,  asking is this back pay and how much.

It seems to me you would only know the answer would be yes if you were informed in other communication (outside the 1099-misc)  that the 1099-MISC amount contained actual pay and how much of the amount on line 3 is actual pay and how much is penalty.

So, I'd like to understand what turbotax does if you check yes on the back pay question.  Does it then make entries in the tax return that will cause payroll taxes?

[Opus 17 · Accepted solution]

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@leimann00 wrote:

That's good to know.

This is in the 1099-Misc part of Turbotax where legal settlement is checked.   A question then pops up,  asking is this back pay and how much.

It seems to me you would only know the answer would be yes if you were informed in other communication (outside the 1099-misc)  that the 1099-MISC amount contained actual pay and how much of the amount on line 3 is actual pay and how much is penalty.

So, I'd like to understand what turbotax does if you check yes on the back pay question.  Does it then make entries in the tax return that will cause payroll taxes?

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If you answer yes that it is back pay, Turbotax will fill out a substitute W-2 form and will collect 7.65% in social security and medicare taxes (or it might be the SS-8 form for uncollected payroll taxes.  Either way, 7.65%.)   This is the correct procedure if, in fact, it was wages reported on a 1099 instead of a W-2. 

People need to be responsible for their own lives at some point.  If someone receives a legal settlement and gets both a W-2 and a 1099, or a 1099 only, and they don't know what it means, they should reach out, as you did, for tax advice or to the attorney who handled the settlement.  

[leimann00]

Thank you so much for that answer!!!

That clears it up for me.  

I now have confidence on what to do!

And thank you all who replied you've been a help to me!

Neal