How do I compensate for an incorrect 1099-MISC?

Question

I received a settlement from my former employer for unpaid wages. In addition to the unpaid wages, the settlement also included attorney's fees and statutory damages. (The settlement agreement clearly notes which amounts are which.)

The employer reported the total amount of the settlement in box 7 (nonemployee compensation) of 1099-MISC, which makes the amount subject to self-employment tax.

However, according to e.g. an IRS presentation on the Taxability and Reporting of Wage Settlements and Judgments, this is incorrect. The past wages should have been reported on Form W-2, and the attorney's fees and statutory damages should have been reported in box 3 (other income) of 1099-MISC. None of this should be subject to self-employment tax.

What should I do on my tax return to remedy the situation and avoid paying unnecessary self-employment tax?

(Note: Contacting the employer and asking them to correct this on their end is unlikely to be successful.)

Answer 1

Report the amounts as they are. If the IRS sends a letter asking why your report doesn't match the reporting on the 1099-MISC, you'll respond with the exact explanation you gave in your question and a copy of the said settlement.

That said, I suggest you have a paid professional do that for you, including properly formulating the statements attached to your return, in order to avoid this unnecessary but expected back-and-forth with the IRS afterwards.

Answer 2

I made an appointment with and visited the taxpayer assistance center of my local IRS office. This is what I was told:

• I should contact the employer and ask them to fix this.
• If contacting the employer is not possible or not successful, I should submit a Form SS-8 detailing the situation and providing all relevant details. The SS-8 is separate from the tax return; it is not something that is sent along with it. The IRS will investigate the matter, which will include contacting the employer. The employer could be fined if, for example, it is determined that the employer knowingly misreported this income.
• The SS-8 investigation could take several months. In the meantime, file for an extension on my current return.
• Given that an extension is an extension to file and not an extension to pay (and since I do owe taxes separate from this matter), re-do my tax return (for my own information) as if this income had been properly reported, so that I can determine my actual tax liability. Go ahead and send a check for that amount.
• Alternatively, I could go ahead and file my tax return now, in parallel with the SS-8. I would need to report the 1099-MISC exactly as received and pay the full amount owed based on the incorrect 1099-MISC. Once the SS-8 investigation is complete, I would receive a refund (with interest) for any overpayment.