Received a 1099-MISC for settlement that is nontaxable?

[tabularasasm]

I settled an ERISA long term disability lawsuit in 2024. I paid taxes on my insurance premiums, so the settlement is nontaxable. However, the insurer issued a 1099-MISC for the entire amount (my portion + my attorney's cut).

Is there some other form they should've used? Should they have sent me a tax form at all? As it stands, I don't think I can efile because I'd need to add an explanation with supporting documents to show exactly what the settlement was for and that I paid taxes on monthly premiums. It's really annoying.

If relevant: In prior tax years, I'd receive W-2s annually with the amount I received, along with the "Third party sick pay" box marked.

[SabrinaD2]

Here’s how to handle your nontaxable ERISA settlement and address the 1099-MISC reporting requirements, and other questions.

If the settlement is nontaxable, should they have issued a 1099-MISC? Should they have sent a tax form at all?
If the settlement isn't taxed because you paid taxes on your insurance, the insurer doesn't have to send you a 1099-MISC. However, some companies may issue 1099-MISC forms for reporting purposes to the IRS, even if the income is nontaxable.  Since the firm did issue a1099-MISC,  you should include the 1099-MISC on your return to avoid discrepancies with the IRS.

In the past, your payments were reported on a W-2 as wages that you had to pay taxes on. This was common for sick pay from a third party. Settlement payments, like those from an ERISA long-term disability lawsuit, are generally reported on a 1099-MISC to reflect non-wage income. This change in reporting doesn't affect how much you owe. You should report the 1099-MISC and adjust for any amounts that are not taxed. For more details, refer to IRS Publication 4345.

Can you e-file or will you need to include an explanation with supporting documents?
Option 1: You can e-file with TurboTax using the steps below. TurboTax doesn't normally provide a place attachments for e-filed returns, but you can keep your supporting documents (e.g., settlement details and proof of taxable premiums paid) on hand in case of an IRS inquiry. Option 2:  If you feel more comfortable explaining the nontaxable nature of the settlement upfront, you can file by mail and include a written explanation along with your return.

Steps to enter the 1099-MISC as nontaxable in TurboTax:

Enter the 1099-MISC:

1. Open your TurboTax return.
2. Click on the "Income" section.
3. Click "Add Income" and select "Other Common Income," then choose "Form 1099-MISC."
4. Go back to the Income section and enter the details from your 1099-MISC exactly as they appear.
5. When prompted to describe the reason for the 1099-MISC, enter "ERISA lawsuit settlement."
6. On the "Does one of these uncommon situations apply?" screen, select "This was money from a lawsuit settlement."

Adjust for Nontaxable Income:

1. Navigate back to the "Income" section.
2. Click "Add Income" and scroll to "Less Common Income," then select "Miscellaneous Income, 1099-A, 1099-C."
3. Go back to the Income section and choose "Other reportable income."
4. Enter a description like "Nontaxable ERISA settlement adjustment" and input the settlement amount as a negative number (e.g., "-$10,000").

This ensures the IRS recognizes the 1099-MISC while correctly reflecting the settlement as nontaxable.

For more IRS guidance on the taxability of settlements, visit the IRS Lawsuit Settlements Guide.
For more help with TurboTax, refer to this TurboTax article.

This ensures the IRS recognizes the 1099-MISC while correctly reflecting the settlement as nontaxable.  For more IRS information about the taxability of settlements, click here.