What is the correct state to apply 1099-MISC settlement damages to: the one where the settlement for the work was done, or my current resident state?

[Pfx]

Background: while this is similar to other questions about 1099s, this situation still feels unique. I received a lawsuit settlement from an old employer related to work performed years ago when I both lived and worked in a previous state (CT). Part of that settlement was reported as back-wages on a W-2, with CT income tax withheld. It is clear that income must be reported as non-resident wages to CT. I also received a 1099-MISC with "statutory multiplier damages" paid in Box 3. No federal or state taxes were withheld. Because this is not wage income, per se, do I report it as earned in my current resident state? Or is is still considered CT income like the wage portion of the settlement. (Btw, I'm taking for granted that statutory multiplier damages are fully taxable, but would LOVE to be mistaken.) Thanks!

[KittyM · Accepted solution]

Normally, income is reported to the state where you receive it - that is why the W-2 shows wages for Connecticut, because that is where you were living when you earned the wages.

Your 1099-MISC, however, is not earned income.  (It is "Other Income" and should be entered as below.)  You should consult with your lawyer to be certain, but your 1099-MISC is taxable to both states.  Remember you can get a Credit for Taxes Paid to Another State on your Resident state return.  Just be certain you do your Non-resident state return first. 

Punitive damages are taxable and should be reported as “Other Income” on Form 1040, Schedule 1, Line 21, even if the punitive damages were received in a settlement for personal physical injuries. 

Bear in mind that an employee is allowed an above-the-line deduction for amounts attributable to attorneys’ fees and costs received on account of certain discrimination/retaliation claims, whistleblower claims, and civil rights claims. In those circumstances, an employee may be able to deduct legal expenses incurred incurred during his or her lawsuit.  

To correctly enter the 1099-MISC so that it does not prompt a Schedule C, take the following steps:

• In your open Federal return, choose the tab for Wages & Income
• Tab through or down to Other Common Income  (you may have to choose Add more income and then See more income to view this topic) and then Show More
• Start/Revisit Form 1099-MISC
• Edit the 1099-MISC if you already entered it, or Add it now and enter the information on the form, then Continue.
• On the screen Describe the reason for this 1099-MISC enter your description.
• On the screen Does one of these uncommon situations apply? choose None of these apply.
• On the screen Did the [Description] involve work that's like [Name's] main job? answer No.
• On the next screen, choose the year you received the money.  (In this case, 2018.)
• On the screen Did the [Description] involve an intent to earn money? choose No and complete the interview.

This will place the 1099-MISC on Form 1040, Schedule 1, Line 21.  To enter your deductible attorney fees and costs (if applicable),

• In your open Federal return, choose the tab for Wages & Income
• Scroll down to Less Common Income and Show more
• Start/Revisit Miscellaneous Income and choose Other reportable income 
• Say Yes to continue to the screen "Other Taxable Income". Enter your description  and the amount as a negative number. 

A corresponding entry will appear on Form 1040, Schedule 1, Line 21 of your return.  You may not see it, but it's there.

[edited 2.21.19 | 8:25 am]

[KittyM]

@palmerfx If your 1099-MISC is taxable to both states, remember you can get a Credit for Taxes Paid to Another State on your Resident state return.  Just be certain you do your Non-resident state return first.  I've updated my answer to reflect this.