Wage Settlement From State

Today TaxMama® hears from Ken in the TaxQuips Forum with this happy news. “Several years ago I worked for a company that ran out of money and couldn’t make payroll. I continued to work for several months with the promise that the wages would be paid. Eventually, I requested a layoff and left the company. In 2011 my state sent me a letter stating that they were attempting to collect minimum wages from the company. Later that year, I received a lump sum payment directly from the state. The attached letter said that they are not required to report the payment; and no 1099 was received. So where should I report this income on my 2011 tax return? Other income 1040 Line 21?”

Ask TaxMama

Hi Ken,

Well done! I am glad you had the gumption to go after this.

What you’re receiving is, essentially, your lost wages. There may be a couple of ways to handle this, one of which you won’t like as well. Yes, the fast and easy way to do this is Line 21 other income and call it recovered wages. File on paper and include an explanation with a copy of the letter from the state.

Why? When you disclose all the information and IRS doesn’t assess anything, they can only come back for up to three years, instead of six, for any additional money. You’d rather find out right away if you’re reporting this properly.

The other way is Line 7 wages – and you need to pay your half of the Social Security and Medicare taxes. You would use Form 8919…hmmm, there’s no code for something like this on Form 8919. Interesting.

The old way to get your Social Security and Medicare taxes paid and into your Social Security record was to use Form 4137, the Tip Income form.

You decide which way to go.

Consider version 1 and let IRS tell you if you’re wrong. You will have made a good-faith effort to disclose the situation. So you will avoid any underpayment penalties if IRS decides you owe the SS/Medi taxes.

And congratulations for getting paid!

And remember, you can find answers to all kinds of questions about settlements and other tax issues, free. Where? Where else? At www.TaxMama.com.

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