Lawsuit Settlement 1099

[jctx]

I have a client that received a settlement late 2021 but the proceeds are in escrow. The client cannot access or has no control over the escrow account.  The issue is a 1099 was issued as other income for 2021 but the funds may not be released for several months due to a lien attached to the escrow in a lawsuit by a previous attorney.  The settlement is large and will be taxable when released. The issue is the IRS will want to tax client based on the filed 1099 for 2021. How can this be shown as income in 2022 when the funds should be released late this year. The issuer will not retract the 1099 because the funds were paid but into escrow. Client does not have the funds to pay the taxes without the settlement money in hand. Thank you in advance. 

[Just-Lisa-Now-]

what kind of 1099 income is it? where on the return does it belong?

[jctx]

We know it will be taxable (1099 MISC - Other Income) from a taxable settlement.  The issue is the 1099 is issued for 2021 but the funds are in escrow and will not be able to be accessed until a lien is removed from another lawsuit attaching the lien...which may take several months or so in court.  We are trying to see if there is a way that makes this a non taxable event (2021) until money is actually received (2022) since taxpayer has no rights to the funds in escrow right now for 2021.  But IRS will see a filed 1099 for 2021 and expect taxes due.

[Just-Lisa-Now-]

Id enter the 1099MISC as received then make an adjusting negative entry on the Other Income line with a description about lack of constructive receipt, then be sure to pick it up on the 2022 return.

[qbteachmt]

You are asking about constructive receipt and a disputed liability:

"Treasury Regulation Section 1.451-2 states the "constructively received" issue thusly:
(a) General Rule. Income, although not actually reduced to a taxpayer's possession is constructively received by him in the taxable year during which it is credited to his account, set apart for him, or otherwise made available so that he may draw upon it at any time, or so that he could have drawn upon it during the taxable year if notice of intention to withdraw had been given. However, income is not constructively received if the taxpayer's control of its receipt is subject to substantial limitations or restrictions."

I'm not sure a lien (personal liability) bypasses this, because it was available to lien in the first place. It is considered for the benefit of that taxpayer and not sheltered. Usually, you put money in escrow to shelter it, and that didn't happen here. What they should have done is make an escrow account for this second lawsuit, and the first settlement would go directly into the new escrow account that is between your taxpayer and the second lawyer. That way, it isn't considered his until this second lawsuit settles. That's what happens with insurance settlements. If you make the escrow now for the second lawsuit, the taxpayer would be able to contribute the money into it, but that proves it should be considered gross taxable income. Perhaps that second lawyer will let him hold back some of it for paying the taxes owed.

You might want to bring in a tax lawyer on this one.