Why is a liability payment that went directly to a contractor counted as income for me on a 1099-misc??

[vnpfischer]

The closing attorney missed a buried waterline; his liability ins co paid $39,147.00 which was the cost to move the line. They sent me a 1099-MISC for that amount. Why is it income for me? They sent me the check but I didn't get the money, it went to the contractor.

[maglib · Accepted solution]

Unfortunately, in cases where there is no physical injury or sickness involved, such as wrongful employment discharge, employment related, discrimination, libel, etc., awards are typically taxable.  Damages received related to economic loss, lost wages/income, and benefits are also all taxable.  

Loss-in-value of property • Property settlements for loss in value of 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. For more information, see the Instructions for Schedule D, (Form 1040) Capital Gains and Losses and the Instructions for Form 4797, Sales of Business Property.

The amounts should be reported in box 3 of the 1099-MISC to avoid paying self-employment tax, as opposed to box 7. 

See this IRS publication for further clarification on settlements & taxes:  https://www.irs.gov/pub/irs-pdf/p4345.pdf

Any portion of the proceeds that are for "pain & suffering" or are punitive in nature are taxable income.  Since you received a 1099-Misc, your settlement may fall under this category.

To enter this in Turbo Tax enter your 1099-Misc.  When asked why you received the 1099-Misc select "I got this 1099-Misc for another reason" and then "This was money from a lawsuit settlement".  I have attached a screen shot of this page for your reference.

If it's claiming as loss of value of property, you would have to create an offsetting entry in TT as the IRS will expect you to report the 1099. You enter an offsetting entry And put a negative amount and choose that non-taxable 1099 for loss of value in property. 

I hope this helps.  If it does not adequately address your concern, please reply to this post so that I may continue to assist you.

You may also be able to claim attorney fees related to this income and other costs but they would be as other expenses and only qualify if you can itemize and are subject to 2% of AGI limitation rules.