In California, workers’ compensation benefits are generally not taxable. However, there are 4 types of payments that can be taxed:
- wages from light duty,
- retirement benefits,
- Social Security offsets, and
- medical expenses that you paid out-of-pocket and then deducted from your taxes.
These payments are taxed at the state and federal levels.
When are workers’ compensation benefits taxable?
The workers’ compensation benefits that you receive in California are not taxable by the State of California or by the federal government so long as they are pursuant to a valid workers’ compensation act.1 This is because the workers’ comp system is funded by taxpayers. Taxing the public benefits offered by workers’ compensation law would create a needless transaction.
However, there are some wages, benefits, and other payments that can be taxed. While these are usually not your workers’ comp benefits, themselves, they are common transactions to occur during the workers’ comp process.
Understanding your potential tax situation can help you make an informed decision about how to settle your case.
1. Light duty wages
The most common payment to be taxed in your workers’ comp situation are your light duty wages. These are wages, not workers’ compensation benefits.
Light or modified duty is a temporary work assignment. It lets you return to work while still physically limited by your workplace injuries. However, because the job duties are less demanding, the pay is also usually lower, as well.
In California, 66 percent, or two-thirds, of that reduction in your wage is covered by your workers’ comp benefits.2 This portion of your lost wages is not taxable.
However, the payments that you earn for working light duty are wages. These are taxable by state and federal income tax.
For example: Jerry makes $1,000 per week but then he gets hurt. He works light duty while he recovers and makes $700 per week. His wage loss is $300 per week. Workers’ compensation benefits cover two-thirds of that loss, or $200 per week. The $200 in workers’ comp benefits are not taxable. The $700 he makes in light duty wages is taxed.
2. Retirement benefits
Similarly, any retirement benefits that you receive are taxable by the state or federal government. Even if you receive these benefits because of your work injury, they are not workers’ comp benefits.
This is an issue if you suffer a work injury or an occupational disease and decide to retire because of it. Even if your retirement is solely the result of your injury, your retirement benefits do not become workers’ comp benefits. They are taxable by state and federal law as retirement benefits.
3. Social Security offsets
In some cases, you can receive permanent disability benefits from more than one of the following sources:
- California’s workers’ compensation law,
- federal Social Security Disability Insurance (SSDI), and/or
- federal Supplemental Security Income (SSI).
If you receive multiple types of these benefits, they cannot total more than 80 percent of your average pre-injury earnings.3 If you would receive more than this limit, your Social Security benefits are reduced. This is known as the SSDI offset or the SSI offset. The state workers’ compensation benefits that replace these federal Social Security benefits, however, are taxed like SSDI or SSI money for federal income tax purposes.
This is the only situation where taxes will apply to workers’ compensation benefits. All of these other exceptions deal with situations where the benefits are not actually workers’ comp.
4. Deducted medical expenses
Workers’ comp benefits include your medical care. However, there will be circumstances where you pay out-of-pocket for care. You may be able to deduct these expenses from your taxable income. If you do, though, and then you receive workers’ compensation to reimburse you for those expenses, you will have to pay tax on that reimbursement. This is to prevent a windfall. You cannot deduct the same payment from your tax return more than once.
What about death benefits?
Death benefits are paid after a fatal workplace accident. They are paid to the victim’s surviving spouse or any dependents with eligibility to receive them. These are a form of workers’ comp benefit. They are tax-exempt.
What does workers’ comp cover?
In California, workers’ compensation covers your:
- medical expenses, and
- lost wages.
This is significantly less than what can be recovered in a personal injury lawsuit. You cannot recover compensation for your pain and suffering and other similar losses in a workers’ comp claim.
Your medical bills are paid for by your employer’s workers’ comp insurer. The insurance company generally pays these up-front in California. They often have the bills sent directly to the insurance company. If you make any out-of-pocket payments, they can be reimbursed by the workers’ comp insurer. However, in order to get your medical bills covered you generally have to go to doctors chosen by your employer.
Your lost wages come in the form of disability benefits. There are 2 types of disability benefits in California:
- temporary, and
Temporary disability benefits are paid while you recover. If you cannot work during this time, you can receive temporary total benefits to cover two-thirds of your complete loss of income.4 If you can only work in a lighter capacity during this time, you would receive temporary partial benefits. These cover two-thirds of the reduction in your income.5
You generally receive temporary benefits until you reach maximum medical improvement (MMI). This is the point at which further healthcare would not improve your condition.
Healthcare professionals will assign a disability rating to your injuries. This reflects how debilitating your injury is to your working life.6
Your disability rating will then be used to calculate your permanent disability benefits. If you cannot work at all, you are entitled to permanent total disability benefits that cover two-thirds of your complete loss of future earning capacity. If you can only work in a lesser capacity than before, you are entitled to receive permanent partial benefits. These cover two-thirds of your reduced earning capacity.7
What types of workers’ compensation settlements are there?
Workers’ compensation claims can be settled with either a:
- compromise and release, or
- stipulation and award.
Most claims settle in a compromise and release in California. In a compromise and release, the workers’ comp insurance company and your lawyer agree to a lump sum settlement. This single payment covers your:
- future medical care, and
- all disability payments.
Some workers’ comp settlements are in the form of a stipulation and award. In these settlements, the insurance company agrees to pay for:
- your future medical expenses as their arise, and
- ongoing disability benefits at a rate stipulated in the settlement.
By getting the legal advice of a workers’ compensation attorney, you can maximize your settlement for your work-related injury and minimize the payouts for tax liability.
Are these settlements deductible on my taxes?
While the payments you receive through workers’ compensation are not taxable, they are not deductible, either. However, your employer can take the following deductions from its tax payments:
- any premium payments it makes to its workers’ compensation insurance company, and
- workers’ compensation payments it makes to injured workers.
These are business expenses.
- Internal Revenue Service (IRS) Publication 525, Taxable and Nontaxable Income (2022).
- California Labor Code 4653 LAB.
- See Social Security Administration (SSA) Handbook, section 504.2.
- California Labor Code 4653 LAB.
- California Labor Code 4654 LAB.
- California Labor Code 4660.1 LAB.
- California Labor Code 4658 LAB.