Your workers’ compensation payments are generally not taxable at the federal or state level. However, a portion may be taxed if you are also receiving Social Security Disability Insurance (SSDI), of if you deducted any medical expenses that you paid. Any retirement benefits you receive are also taxable, even if you only retired because you got hurt at work.
When are workers’ compensation benefits taxable income?
Generally, your workers’ comp benefits are not taxable income, so long as they come from a workers’ comp act or a statute that is in the nature of a workers’ compensation act.1 This includes a spouse’s survivor benefits, also known as death benefits. At both the state and federal levels, these benefits have a tax-exempt status alongside other government benefits, like public welfare or compensation for personal injury claims.
However, there are 2 times when workers’ comp benefits can be taxed. These are when you receive:
- workers compensation benefits after deducting your medical expenses, or
- SSDI benefits.
Additionally, any retirement benefits you receive will be taxable, as well.
Other than these tax situations, though, your workers’ comp settlement is income tax-free. Injured workers will not have tax liability for the money received, though they will have to report it on their state and federal tax return.
A workers’ compensation attorney from a reputable law firm can ensure that your entire claim maintains its tax exemption.
You deducted your medical expenses
A big part of your workers’ compensation benefits are having your medical expenses paid for. However, you may still end up paying some of these expenses out-of-pocket. If you deduct these expenses from your taxes, you will have to pay tax on your workers’ compensation award to make up the difference. This avoids a potential windfall.
Workers who suffer a permanent disability can end up receiving disability insurance and workers’ comp benefits at the same time. When you receive both workers’ comp and SSDI benefits, the combination of those benefits cannot exceed 80 percent of your average current earnings.2
Your average current earnings are the largest of the following:
- your average monthly wage that was used to determine your disability payments,
- 1/60th of your total wages from your highest-paid 5 consecutive years, or
- 1/12th of your total wages from your highest-paid year of the last 5 years.3
If your workers’ compensation elevates your benefits above 80 percent of this number, your SSDI benefits are usually reduced. This is called a workers’ compensation offset. This offset is calculated only after subtracting payments to dependents, as well as medical costs and legal fees. The amount of that offset – the portion of your workers’ comp award that replaced your SSDI income – is taxable like SSDI.
In some states, it will be your workers’ compensation benefits that get reduced by your SSDI benefits. This is known as a “reverse offset.” Your workers’ comp will not be taxed, though your social security benefits will continue to be taxed normally.
Any retirement benefits that you receive are taxable. This is the case, even if you only retired because of a work-related injury or an occupational disease that led to your workers’ compensation benefits.
Are workers’ comp benefits deductible?
The workers’ compensation payments that you receive are not deductible from your taxes. However, your employer can deduct the following payments on its taxes:
- its premium payments to the workers’ compensation insurance company, and
- workers’ comp benefits.
What does my workers’ compensation settlement cover?
Your workers’ compensation settlement aims to cover the following expenses after a workplace injury:
- medical bills, and
- lost wages.
Importantly, a workers’ compensation claim does not cover other losses, like your pain and suffering.
Your medical bills are covered by providing medical care and reimbursing you for any healthcare costs you have paid that are associated with the injury. However, you generally have to go to healthcare professionals that are chosen by your employer.
Your lost wages are covered by disability payments. These come in 4 forms:
- temporary partial disability,
- temporary total disability,
- permanent partial disability, and
- permanent total disability.
Temporary disability payments cover the wages you have lost while recovering. If you were completely unable to work during this period, you can recover temporary total disability payments. If you could work in a lesser capacity or on light duty, you can be entitled to temporary partial disability payments.
Permanent disability payments cover the wages you will lose after recovering. If you can work in a lesser capacity or under restrictions, you may be entitled to permanent partial disability coverage. If you cannot work at all, you can receive permanent total disability benefits. These can be paid in a structured settlement or in a lump sum.
You will generally need to reach maximum medical improvement (MMI) for a partial disability to turn into a total one.
All of these disability payments are capped at an amount set by state statute. It is often 2/3rds, or 66 percent, of your wage before the injury.4
The best way to ensure eligibility and to maximize the value of your workers’ comp payments is to get the legal advice of a lawyer to help file your claim.
- Internal Revenue Service (IRS) Publication 525, Taxable and Nontaxable Income (2021).
- See Social Security Administration (SSA) Handbook, section 504.2.
- Same at 504.3.
- See California Labor Code 4658 LAB.