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?

[aadubey]

I have looked on my Schedule A, and I do not see a line to enter this settlement amount to offset the 1099 Misc.

[Opus 17]

What exactly is the settlement for?

[aadubey]

Wrongful Foreclosure of my home. The amount was the difference between the actual value of my home and what it was sold for at auction. So it was for actual loss, not punitive.

[Opus 17]

If you had sold the home, would you have qualified for the capital gains exclusion based on the number of years you lived there and owned it?  If you had sold the home for the price that you settled for, would you have owed capital gains tax?

[aadubey]

I had owned the home for 12 years. So I am not sure if I owe capital gains or not.

[Opus 17]

You would've qualified to exclude $250,000 of your gain if you were single or head of household, and $500,000 of gain if you were married filing jointly.   Any gain over that amount would be taxed as a long-term capital gains to you.

You could have owed capital gains tax even if you were foreclosed. For example, if you bought the home for $200,000, and it had a foreclosure value of $800,000, that would be a $600,000 capital gain. The fact that you might have taken out a second mortgage or home-equity loans that you could not pay would not change the fact that you have a capital gain.

 The point of all of this, is that if you would have owed capital gains tax if you had sold the home for the adjusted price, or if you would have owed capital gains it on the foreclosure at the adjusted price, then the settlement is probably taxable as a capital gains. Because it would have been taxable if it had been part of the sale or foreclosure price.   However, if you would not have owed capital gains tax, then the settlement is not taxable either.

 We may need more facts and figures on the foreclosure of the house.   Or, you may want to see a professional tax advisor.

 There are two possible procedures on how to deal with the 1099 form that needs to be reported differently, but I'm not yet sure whether or how this should be reported.

[aadubey]

The home was worth $255,000 and was sold for $170,000 at auction. The Settlement was for $85,000. So it would appear that I don't owe capital gains tax.

[Opus 17]

@Hal_Al I think you have a canned answer that can help here.

[Opus 17]

There are three ways to deal with this.

1. Contact the payer and try and get the form rescinded.

2. The tax instructions say that if you receive a 1099-MISC in error, you don't report it as income.  You will need to file by mail; you can't e-file.  Attach a copy of the 1099-MISC to your tax return along with a written statement explaining why the income is not taxable and the 1099-MISC was entered in error.  In your case, you would explain that this was a settlement for lost value of your home in a mistaken foreclosure; that the settlement represents a capital gain on your home; that you qualify for the $250,000/$500,000 exclusion based on your ownership and residency; and that even with the settlement included, your gain would be less than the exclusion amount, so it is not taxable.

The IRS has been known to lose such letters, so keep copies of everything in case they send you a letter later wondering why you didn't report it.

3. You can report the $85K as taxable income, then  go to the "other income" section and create an item with an offsetting negative amount (-$85K) and then e-file your return.  I personally don't like the idea of adding fake information to a tax return just to get it to e-file, and we have seen occasional reports that the IRS will send letters asking for an explanation.  But the procedure does exist and can be used if you want to.  I think @Hal_Al has a walk-through of how to do this in the program.

[Hal_Al]

Report the income as misc line 21 income* (enter in TurboTax at the 1099-Misc screen) .  Then enter a line 21 deduction, for the same amount.  In TurboTax (TT), enter at:
- Federal Taxes tab
 - Wages & Income
- “I’ll choose what I work on” Button
Scroll down to:
-Less Common Income
      -Misc Income, 1099-A, 1099-C
       - On the next screen, choose – Other reportable income - Enter the number with a minus sign (-) in front. Briefly explain at description.

*Line 8 of Schedule 1 on the 2019 and 2020 forms and line 21 of schedule 1 on the 2018 forms. 

[aadubey]

Thanks for the help!

[BTC198]

Hello, Is there a way to enter this same/similar situation on the current 2020 version of Turbo Tax.

On Schedule 1, line 8, I already entered 2 separate entries in the 1099-NEC (this is the form I received) section and they net out to $0 shown on the Schedule 1. But I want both amounts to show (positive being offset with negative) and a description of "Non-taxable compensation under IRC section 104(A)(2)".

So basically, is there a way to show 2 line items on Schedule 1, line 8? Something like this...

COMPANY NAME     $XX,XXX

"NON-TAXABLE..."   -$XX,XXX                                 

TOTAL NETTING TO $0

[Opus 17]

---

@BTC198 wrote:

Hello, Is there a way to enter this same/similar situation on the current 2020 version of Turbo Tax.

On Schedule 1, line 8, I already entered 2 separate entries in the 1099-NEC (this is the form I received) section and they net out to $0 shown on the Schedule 1. But I want both amounts to show (positive being offset with negative) and a description of "Non-taxable compensation under IRC section 104(A)(2)".

So basically, is there a way to show 2 line items on Schedule 1, line 8? Something like this...

COMPANY NAME     $XX,XXX

"NON-TAXABLE..."   -$XX,XXX                                 

TOTAL NETTING TO $0

---

I don't like the "negative entry" method in any case.  If turbotax is netting the entry to zero for line 8, you would have to use the desktop version installed on your own computer, go to forms mode, and type the explanation in yourself.

Also be aware that the IRS will almost certainly send you a letter demanding you prepare a schedule SE and pay SE tax.  It will be triggered by the 1099-NEC, because the IRS will assume that all 1099-NEC income is compensation for services performed.  Anything you write in the tax form is unlikely to stop the automated assessment, assuming someone even reads your comments.  You will need to respond with documents showing why this money is not compensation for working.  

[Critter-3]

Why did you get a 1099-NEC?   Was this for income replacement of some kind ?   If so you cannot just negate it on the Sch 1 as you indicate.  

[BTC198]

This was from a settlement, PTSD damages paid from an old employer.  I know it is not black and white regarding whether PTSD is considered physical injury or not.  Let's just say this is non-taxable. 

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?