If I recently settled an out of court lawsuit against my Long Term Disability Insurance company, do I need to report this settlement as income?

[Opus 17]

 That depends on the original disability insurance plan. Legal settlements are taxable or not according to the kind of income they replaced. Disability insurance payouts are taxable if your employer paid the premiums for you tax free, but are not taxable if you paid the premiums after-tax.  In some cases, when an employer provides a basic level of protection and the employee pays for extra protection, then part of the payment is taxable and part is nontaxable, and this will usually be reflected on a 1099 form or W-2 form sent by the disability insurance company at the end of the year.

I am assuming that the insurance company denied your claim at first, and you have now settled that they should pay a disability claim to you. In that case, you have to go back and look at the original disability insurance plan and how it was paid for, to determine whether all, part, or none of the settlement is taxable.

 This may be reflected on a 1099 or W-2 form that the insurance company sends you in January, now that you have settled. If you get a form that seems to disagree with what you think the taxability of the payment should be, you can write back here for further information on how to adjust your tax return. 

[penguin805]

I have the same situation (my Employer paid a portion of the Premium & I paid a portion of the Premium - Post Tax); and my 1099 MISC disagrees (indicates the full amount as Other Income in Box 3). The Insurance Company states I need to defer to my Disability Lawyer/CPA and my lawyer states I need to defer to a CPA. I have tried to determine how to adjust my tax return without being taxed on the full lump sum but, I am at a loss. Are you able to advise? Thank you in advance.

[Opus 17]

There are two things you could do in turbotax.  But, we on this forum are not CPAs.  If you really want expert advice you'd best pay for it.

1. Report "other income" in the amount you believe to be taxable, under other miscellaneous income or other uncommon income.  (That's where box 3 income goes anyway.)  Don't report the 1099-MISC separately.  You may get a letter asking why you did not report the 1099, you will send back a written explanation.

2. Report the 1099-MISC box 3 income, then go to other uncommon income and create an entry with a negative number in the amount of the non-taxable part of the settlement, to offset the 1099.  Label it something like "non-taxable adjustment" or whatever you think will be informative.  We are hearing, although I can't confirm, that negative adjustment entries like this are blocking e-filing this year so you may have to mail your return.  If you do, you might as well attach a written explanation of the adjustment (why only part of the 1099 is taxable.)

This is not a complete answer because it does not deal with the issue of social security and medicare tax that maybe should have been paid on the part of the settlement that would have been reported on a W-2 if the employer did things correctly in the first place.  That really would need a CPA if you want to verify whether or not you need to pay that tax off the settlement and how to do it.