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.

[BerkshireRun]

Hi,

I received a settlement from Vanguard because I lvie in Massachusetts and the state filed a lawsuit saying the Vanguard clients were not properly notified about sell offs that result in extra high capital gains. 

So I paid an extra 25k in taxes in 2021 but got a 25k settlement check in 2024. I also got a 1099.  

Is this settlement amount taxable? It seems to me it is reimburing me for a wrong and should not be taxable.

Allison 

[MonikaK1]

Whether and how much of the amount of a legal settlement is taxable depends on the type of settlement proceeds you received and what they represented. Since you received a Form 1099, it should be accounted for on your tax return, as the IRS information return matching program will be looking for it.

Check the terms of the legal settlement. If you received punitive damages, this would be taxable income. 

Property settlements that compensate for a loss in value of your property that are less than the adjusted basis of your property are not taxable and generally do not need to be reported on your tax return. However, you must reduce your basis in the property by the amount of the settlement. If the property settlement exceeds your adjusted basis in the property, the excess is income. 

if the settlement is fully or partly nontaxable to you because it is compensating you for a loss and not punitive damages, then enter it under Miscellaneous Income, then Other Reportable Income.

You would enter the full amount received as Other Reportable Income;  then, make a second entry with a negative number to take out the nontaxable amount; that way, you would still have the full amount accounted for on your return. Use the explanation fields to describe the payment.

See IRS Publication 4345 for more information about legal settlements.

Legal fees related to personal issues typically can't be included in your itemized deductions under current law. See this tax tips article for more information.

@tabularasasm 

@BerkshireRun