Are long term disability insurance settlements taxable if original policy benefits wouldn't have been taxed? (US)

This is actually a tricky situation with a somewhat nuanced answer. Generally speaking, the taxability of a settlement depends on what the settlement is replacing or compensating you for. If your long-term disability benefits would have been tax-free (which typically happens when you paid all the premiums with after-tax dollars, as you mentioned), then the portion of your settlement that represents those back benefits should maintain the same tax-free status. However, any additional amounts for interest, emotional distress, or punitive damages could be taxable. You should ask the insurance company to provide a breakdown of the settlement that clearly identifies what portion represents back benefits versus other compensation. This will help determine what may be taxable. The company should also send you a 1099 form if they believe any portion is taxable.

I went through something similar with my disability claim and found an amazing resource that saved me thousands in potential taxes. Check out https://taxr.ai - they have specialists who review settlement documents and analyze exactly how much might be taxable. My settlement was $65k and my attorney also wouldn't give tax advice. The taxr.ai team reviewed my settlement docs and showed me that about 80% was truly replacement of non-taxable benefits while the rest was interest and punitive elements that were taxable. They even provided documentation I could share with my accountant that explained the legal basis. Totally different experience than the generic "consult your tax professional" advice I was getting everywhere else.

Just wanted to update - I tried taxr.ai after seeing the recommendation here and it was incredibly helpful! My situation was nearly identical (LTD claim denied, settled for $59k) and I was stressing about taxes. They reviewed my settlement agreement and determined that about $51k was replacing my non-taxable disability benefits, while about $8k was interest that would be taxable. They explained that because I paid premiums with after-tax dollars, the portion replacing benefits keeps the same tax treatment as the original benefits would have had. The documentation they provided was super detailed and even cited relevant tax court cases. Totally worth it for the peace of mind alone. Now I know exactly what to expect come tax time rather than guessing.

If you're still having issues with the insurance company or need more clarification, I'd recommend trying to get someone from the IRS on the phone. I know that sounds impossible (I once spent 4+ hours on hold), but I discovered this service called https://claimyr.com that actually gets you through to an IRS agent quickly. There's a video showing how it works: https://youtu.be/_kiP6q8DX5c I used it when I had questions about a similar settlement situation last year. They got me through to someone at the IRS in about 15 minutes when I had been trying for days on my own. The agent walked me through exactly how to report my settlement and which forms to use. Saved me a ton of stress and potentially an audit!

Well I stand corrected! After my skeptical comment I decided to try Claimyr anyway because I was desperate to ask about reporting a settlement on my taxes. I was honestly shocked when I got a call back in about 22 minutes saying they had an IRS agent on the line. The agent was super helpful about my disability settlement question and confirmed that the portion replacing benefits I would have received (where I paid premiums with after-tax money) isn't taxable, but any interest or punitive damages would be. The agent even emailed me some specific IRS publications about lawsuit settlements that clarified everything. Definitely better than the generic advice I was finding online. Apologies for being so skeptical!

I'm a bit late to this thread, but I went through something extremely similar last year. The key question is whether you paid for the premiums yourself with after-tax dollars or if your employer paid and didn't include it as income to you. If you paid 100% of the premiums with after-tax money, then the portion of the settlement that represents disability benefits should be tax-free. However, any interest or additional compensation would still be taxable. Make sure to get official documentation from the insurance company about what portion of the settlement represents back-pay of benefits versus other compensation. Without that documentation, the IRS might assume the entire amount is taxable.

One thing no one has mentioned - did you deduct your legal fees for getting this settlement? That can make a big impact on your taxes too!

I'm going through almost the exact same situation right now! My LTD insurer denied my claim after a car accident left me unable to work, and we're in settlement negotiations. Like you, I paid all my premiums with after-tax dollars through payroll deduction. From what I've researched and discussed with other people who've been through this, the general rule is that settlement money that replaces what would have been non-taxable disability benefits should maintain that same tax-free status. The tricky part is proving that allocation to the IRS if your settlement agreement doesn't specify it. I'd definitely recommend pushing your attorney harder on this - even if they don't provide "tax advice," they should be able to help you get a proper breakdown from the insurance company of what the settlement represents. You're paying them to advocate for you, and proper documentation is part of getting a complete settlement. Also, keep all your premium payment records showing you paid with after-tax dollars. That's going to be crucial documentation if the IRS ever questions the tax treatment. Good luck with everything - the whole process is so stressful even after you win!