Under Section 104 (a) of the Federal Internal Revenue Code, damages paid due to physical injury or wrongful death are excluded from a person's income tax. This means that if you receive a lump sum settlement for a personal injury or wrongful death case, you will not be subject to taxation. However, if you receive a lump sum settlement for any other type of case, such as a long-term disability claim, the money may be taxable. The tax advantages of structured settlements are generally considered in terms of their benefits over time.
If you paid the premium with money that had already been taxed, then your lump-sum settlement should be tax-free. If you receive a one-time payment, all income received is taxable. You will be subject to federal and state taxes at the same time. The main factor that will help determine whether you should pay taxes for a long-term disability lump-sum settlement is who paid the insurance premium.
If the premium was paid with pre-tax dollars, then the lump sum settlement should be tax-free. However, if the premium was paid with after-tax dollars, then the lump sum settlement may be taxable. IRC Section 104 provides an exclusion from taxable income with respect to lawsuits, settlements, and awards. Just as personal injury settlements are not considered taxable income, so are future sales of these payments, provided that the terms of the contract do not change.
However, keep in mind that you probably owe federal income taxes on the agreement for the year you received it. This calculation provides the insurance company with a discount for paying you a lump sum today, instead of paying monthly benefits over time. If your claim has not been denied, a settlement of between 50 and 80% of the current value of the claim will typically be offered.