How would you handle this?

[RightOn]

Taxpayer had an auto accident in 2011. He received settlement proceeds from the responsible party's insurance company to compensate for both his personal injuries and for his pain and suffering. Such compensation is considered non-taxable (please correct me if anyone thinks I am wrong).

However, his lawyer issued a Form 1099-misc to him and put the settlement amount in box 7 as non-employee compensation. I told him it is incorrect because that means the settlement proceed is fully taxable and he will have to pay self-employment tax on it too. So he went back to his lawyer. The lawyer only gave him a letter that certifies the settlement proceeds is compensation for personal injuries, and pain and suffering.

How would you handle the situation? I am thinking to report the settlement amount in a Schedule C, since it has been reported in a Form 1099-misc already. And then I will cancel it out with a negative amount. And I will attach an explanation with the letter from the lawyer.

Opinion?

[RitaB]

Yeah

Yes, I would write an explanation on the line where you enter the "expense" on the back of Schedule C. "Compensatory damages incorrectly identified by overpaid attorney as compensation," or something.

[Jiggers]

I have seen more and more incorrect 1099's this year than ever before.

The persons that are completing the 1099's are probably the secretaries or low-man on the totem pole in bookkeeping. None have ever read the instructions and none have any clue on how to complete.

Most have the amounts in the wrong box. Most all show as non-employee compensation when it is rent, other income, or royalties.

The clients have no clue either.

And trying to get the original preparer to correct is like pulling teeth.

[RitaB]

My experience

The persons that are completing the 1099's are probably the secretaries or low-man on the totem pole in bookkeeping.

My experience with attorneys has been that the secretaries read directions better than the attorneys. LOL.

[New York Enrolled Agent]

Taxpayer had an auto accident in 2011. He received settlement proceeds from the responsible party's insurance company to compensate for both his personal injuries and for his pain and suffering. Such compensation is considered non-taxable (please correct me if anyone thinks I am wrong).

However, his lawyer issued a Form 1099-misc to him and put the settlement amount in box 7 as non-employee compensation. I told him it is incorrect because that means the settlement proceed is fully taxable and he will have to pay self-employment tax on it too. So he went back to his lawyer. The lawyer only gave him a letter that certifies the settlement proceeds is compensation for personal injuries, and pain and suffering.

How would you handle the situation? I am thinking to report the settlement amount in a Schedule C, since it has been reported in a Form 1099-misc already. And then I will cancel it out with a negative amount. And I will attach an explanation with the letter from the lawyer.

Opinion?

I would suggest you ask the lawyer to re-write the letter to state it was for personal physical injuries. §104(a) excludes from income amounts received for physical injury. I don't know how old the lawyer is but that code section was changed by the SBJA in 1996. Prior to that, it was simply personal injury.

[MilTaxEA]

The IRS has published the "Lawsuits, Awards, and Settlements Audit Techniques Guide", which is useful to determine exactly which types of lawsuits can be excluded from income.

[taxea]

The attorney should correct the 1099...and either zero it out or enter 0 in the taxable box.

If I couldn't get the 1099 corrected I would enter it on Ln 21, make the appropriate adjustment and include an explanation as to why it is not taxable.