Do You Have to Pay Taxes On Workers’ Comp?
Workers’ compensation benefits are generally considered non-taxable whether you receive weekly payments or a lump-sum settlement. This is true at both the federal and state level, according to applicable employment law. But there are a few exceptions.
Consider what workers’ comp typically helps pay for:
- Illnesses or injuries;
- Lost wages;
- Ongoing care;
- Disability benefits;
- Funeral costs.
People on workers’ comp, however, may also receive income through Social Security disability insurance (SSDI) or Supplemental Security Income (SSI). To keep a person’s combined benefits and payments below a certain threshold, a small portion of workers’ comp may become taxable. Filing taxes becomes more complicated the greater the sum of income you are receiving from all sources. If you run into trouble filing your taxes, or are worried about how your benefit payments may affect your tax bill, it may be best to consult a qualified workers’ comp attorney to help coordinate the settlement terms.
Workers’ Comp and Social Security Disability Taxation
SSDI and workers’ comp both provide benefits to people who are physically unable to work due to a notable disability. However, the two disability benefit programs differ quite dramatically. Workers’ comp is available starting your first day of employment with a company, whereas SSDI typically only applies to those with a substantial work history. SSDI is also only available for those who have long-term disabilities, whereas workers’ comp covers both long- and short-term disabilities. Lastly, SSDI covers disabilities regardless of whether they occurred at work, whereas workers’ comp only assists those who have been injured on-the-job.
Eligible individuals can receive both workers’ comp and SSDI at the same time. But there is one caveat. If you are receiving them concurrently, Social Security may reduce your monthly payments. This is to prevent you from earning more than 80% of your “average current earnings” — and, in other words, is referred to as an offset. The reduction in combined payments, however, never results in an individual being paid less than the total amount of Social Security disability benefits.
Your current average earnings are defined as:
- The average monthly wage on which your disability benefits are based;
- The average monthly wage during your highest five paid consecutive years;
- The average earnings during your highest-paid year of the last five years.
The amount of workers’ comp that is taxable is determined by the amount by which Social Security reduces your disability payments. For example, if your monthly SSDI check is lowered by $300 due to the workers’ comp offset, then that $300 of workers’ comp is taxable.
Is a Workers’ Comp Settlement Taxable?
A workers’ comp settlement is nontaxable, but it is still considered income.
It is important to note that accepting workers’ comp can put you at risk of being disqualified from benefits, such as Medicaid or SSI, because it is considered income. These benefits are only available to individuals who fall under a certain income bracket. If workers’ comp pushes you over that bracket then you will be disqualified from the benefits.
If accepting a settlement puts you at risk of being disqualified from these benefits, then you may want to consider opening up your workers’ comp in a Special Needs Trust. This is a legal arrangement composed of the fiduciary relationship between a donor, a trustee, and a beneficiary. However, as a beneficiary, you relinquish your rights to decide how the money is spent — that is up to the donor.
How to Reduce Your Taxable Income From Your Workers’ Comp Settlement
An attorney in your area can advocate on your behalf to help reduce the amount of taxable income from your workers’ comp settlement. One way to go about this is by agreeing that the settlement is treated as something to spread out over your lifetime. While you’ll still receive a lump sum, instead of periodic payments, it is intended to last the duration of your lifetime. Talk to your lawyer about identifying this in your settlement agreement.
Additional Workers’ Comp Tax Considerations
When applying for workers’ comp keep in mind that it can affect personal finances in your life beyond its own tax-exempt status. Retirement benefits, wages after returning to work, interest payments, and survivor benefits are some areas that may be impacted.
Unlike workers’ comp, retirement benefits are not tax-exempt. Any retirement benefits you receive based on age, years of service, or prior contributions can be taxed even if you retired due to an injury or illness.
Wages From Returning to Work
Many people return to work after becoming injured and receiving workers’ comp. It’s important to remember that the income you gain from returning to work, even if you’re only doing “light work,” is taxable. You may also still receive some amount of workers’ comp.
You may receive interest payments on workers’ comp if the insurance company caused a significant delay or engaged in flagrant behavior. Interest payments, however, are considered taxable income. If it takes a substantial amount of time to start receiving your workers’ comp and you’re paid interest as a reparation, you will not be taxed on the workers’ comp but will be taxed on the interest.
Survivor Benefits to Family Members
In the event of a fatality, workers’ comp goes to the individuals’ surviving family members. Survivor benefits are also not considered taxable income.
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