I've settled out-of-court for a long-term disability claim. The LTD policy premiums were paid with after-tax dollars. Is the out-of-court settlement taxable?

[daniel-chappell]

I became disabled and unable to work, and the insurance company paid benefits before eventually terminating benefits. We took them to court, and they settled before the case went to trial.

[MinhT · Accepted solution]

Long-term disability benefits are not taxable when the insurance premiums are paid with after-tax dollars. As the settlement is considered as your long-term disability benefits, it is not taxable. And any legal fees you incurred are not deductible.

[peter07043]

I have the same situation.  My premiums were paid entirely by me with post tax dollars.  However, just to verify that I won’t owe tax on the out-of-court settlement, I’d like to find this same info on the IRS website.  Can someone point me to this?  I’ve looked high and low.  Thanks.

[TomD8]

@peter07043 :

See pages 17-19, "Sickness and Injury Benefits", in this IRS reference:  https://www.irs.gov/pub/irs-pdf/p525.pdf

[billick]

I have the same situation. I paid no taxes for STD and LTD payments. I received a lump sum as part of settlement in 2019 and received a 1099-MISC from insurance company with Box 3 containing Settlement amount. The remaining boxes are all blank. Do I need to report the income in 1099-MISC? Please advise. Thanks 

[TomD8]

@billick --

Yes, you should enter the 1099-MISC into the appropriate section of TurboTax.  Settlements reported in Box 3 of a 1099-MISC are generally taxable.  Per the IRS:

Generally, all punitive damages (even if they relate to physical injury or physical sickness), any damages for non-physical injuries or sickness, liquidated damages received under the Age Discrimination in Employment Act of 1967, and any other taxable damages are required to be reported in Box 3.

See Page 26, https://www.irs.gov/pub/irs-utl/lawsuitesawardssettlements.pdf

[billick]

My premiums were paid entirely by me with after tax dollars. Not sure why in my case, my lump sump payment is taxable? 

[peter07043]

See TomD8’s reply above. When I had this issue last year, I verified with the IRS and my accountant that if the premiums were paid with after tax dollars the benefit is not taxable (whether as regular LTD monthly payments or as a lump sum settlement as a settlement of a lawsuit. The monies received from a LTD lawsuit are to be taxed the same as the monies they replaced (normal monthly LTD payments). I would speak to your accountant for piece of mind and have documentation available that proves your premiums were paid with after tax dollars.

[TomD8]

@billick --  I agree with @peter07043 but suggest you check with the issuer of the 1099-MISC.

[billick]

I talked to the Issuer and told me it is taxable. I m really so confused. It really does not make any sense since my situation is not different than anyone else here. 

[TomD8]

@billick --  Was your disability insurance coverage obtained through your employer, or was it a private policy that you purchased on your own?

[billick]

it was part of my employers long term disability plan. Disability insurance deduction made after-tax every month on my paycheck. When I was receiving my short-term and long-term monthly payments, I was not subject to any tax. 

[peter07043]

Your settlement should NOT be taxable based on what you’ve stated. 

[TomD8]

If your employer paid any part of the premiums for the disability insurance, at least some of the benefits will be taxable.  See this from the IRS:

https://www.irs.gov/faqs/interest-dividends-other-types-of-income/life-insurance-disability-insuranc...

[TomD8]

- duplicate answer deleted -