Is Your Workers’ Compensation Payment Taxable?

No, workers’ compensation payments are not typically taxable either federally or at the state level. Since these benefits merely replace lost wages caused by on-the-job injuries or illnesses, the IRS considers them non-taxable income. There are exceptions, though — if you get Social Security Disability Insurance (SSDI) or Supplemental Security Income (SSI) and your workers’ comp benefits decrease your payments, some may be subject to taxes. How these tax rules work is key to avoiding nasty surprises when the bill comes due.

What is Worker Compensation?

Workers compensation is a state-mandated insurance program covering injured or sick employees. Typically, these advantages include:

• Medical expenses – Hospital bills, surgery, doctors, medicines, therapies
• Rehabilitation Expenses – Pays for physical therapy and other treatments to help injured employees return to work.
• Lost wages – Compensates employees for lost wages while they cannot work because of injury.
• Disability benefits – Provides compensation for temporary or permanent disabilities caused by job-related injuries.

Although these benefits are vital for injured workers, there is also the matter of how they affect your taxes.

When Are Worker’s Compensation Payments Taxable?

While workers comp benefits are tax-free most of, for the most part, some circumstances may make those benefits taxable:

1. Social Security Benefits Offset for Workers Comp

Some of your workers’ compensation payments may be taxable when you have workers’ and workers’ compensation.

This occurs because the total number of benefits you are eligible for is capped by the Social Security Administration (SSA). However, the SSA will reduce your SSDI/SSI amounts if your combined worker’s compensation and SSDI/SSI benefits exceed 80% of your pre-disability average current earnings. This decrease is referred to as the worker’s compensation offset.

The offset amount you receive is taxable because it is treated as Social Security benefits. The end-of-the-year Form SSA-1099 you receive will indicate the taxable portion of your workers’ compensation payments if this applies to you.

2. Interest from Workers’ Compensation Settlements

For this reason, there are claims where the worker’s comp settlement includes interest payments for the delay in compensating the injured worker. Although your original workers’ compensation payment is not subject to taxes, any interest from your settlement counts as taxable income. You will need to pay taxes on it during tax season.

3. Returning to work with Light Duty pay:

It is important to remember that while your worker’s compensation payments are tax-free if you return to work on light duty or a part-time basis and are still receiving benefits, your wages will be taxable. You have to report these earnings on your tax return as ordinary income.

How to Report Worker’s Compensation on Taxes:

Workers’ compensation is generally not taxable income, so you do not need to report those payments on your tax return in most cases. However, if your WC falls under the SSDI offset rule, the Social Security Administration (SSA) sends you a Form SSA-1099 reflecting the taxable portion of your benefits.

For reporting taxable workers’ compensation payments:

• Check Box 5 on the Form SSA-1099 Review Form – total taxable benefits
• If some of your Social Security benefits are taxable, report that amount on Line 6b of Form 1040.
• Obtain professional tax advice – If there’s any doubt about the taxability of the workers’ compensation payments, it’s advisable to seek expert tax assistance to avoid errors.

Ways to Minimize Tax Liability on Worker’s Compensation:

Even if your worker’s compensation payments don’t get taxed, there are ways to minimize your tax bill:

• Be smart about how you structure your settlement — If you are negotiating a settlement, you can ask for your payments to be broken down across several years to avoid hitting a high tax bracket in one year.
• Explore medical expense deductions — Similar to this, if you had to incur out-of-pocket medical expenses for your work injury, you could qualify for a deduction for those as well.
• Check for state-specific tax rules. Although federal tax law applies to all states, state-specific tax provisions regarding workers’ compensation benefits exist.

Final Thoughts:

Workers’ compensation payments are not subject to tax for most workers and typically provide essential post-injury financial relief. However, some of your payments could be subject to taxation if you receive Social Security benefits or interest on a settlement. With this knowledge, you can plan to maximize benefits tax-efficiently and avoid being caught up in a tax bill you had not anticipated. The best way to guarantee you are abiding by the laws surrounding taxes and saving as much money as possible is to consult a tax professional if you have any doubts about your situation.