I have an ex client that prepaid me for some services in 2012. They then hired someone else to do thier work. I didn't have the money to repay their prepayment at that time so i asked them to take payments. They didn't accept payments and sent me a 1099-misc for the prepayments. Then in May of this year they had an attorney contact me to colloct the money. I have been making payments to them since then with 4.5% interest added on to the bill compounded monthly. How do I report this on my tax return? Also is there anything I should do since I did claim it as income last year. Don't know if it matters but the payments are made to the company not the attorney.

#1;So you’ve been making payments to them since then with 4.5% interest added on to the bill compounded monthly, but they didn't accept payments and sent you a 1099-misc for the prepayments. So they wanted a lump sum money( I guess the remaining amount of the prepaid money) in lieu of accepting monthly payments with interest from you?? This is a legal issue. You need to get some professional legal help form a tax attorney. I think that they sent you a 1099 as they didn’t take the whole amount of the prepaid money back from you, as it was paid to you in 2012 then it needs to be reported as your income on your 2012 return UNLESS you give the whole amount back to the client.( this means that UNLESS the prepaid money is no longer your reportable income as they take it back from you so they themselves also need to report the 1099/1096 to the IRS .This is why a 1099 is for you and for them .Later when they take back the whole of the remaining amount of the prepaid money then they and you need to file 1040X to remove the income/expenses from your /their returns ). However, even if they accept your monthly payments with interest , you can’t deduct your interest expenses as it is your personal expenses, NOT business expenses UNLIKE business loan payments; however, as long as you earn interest income form holding the prepaid money , then you need to report it on your return as your interest income UNLESS you give it back to the client..


#2;As mentioned above, since you did claim it as income last year on your Sch C, once you give it back to your client, then you need to file your amended return for refund on the tax liability on the prepaid income on your return. They, however, need to file their 1040X to pay tax on the prepaid money that they receive back from you as they deducted it on their Sch C as their biz exp. Whether or not, they want a lump sum money is a legal issue , so yu can contact a tax attorney for more info in detail.