Workers’ compensation benefits are a type of insurance that provides support to employees if they suffer from a work-related injury or illness. Whether financial payment for lost wages, medical expenses, or disability benefits, workers’ compensation ensures employers and employees can avoid lawsuits while providing financial protection in an accident.
These finances are vital for many employees, especially those who now rely on disability or workers’ compensation finances to support their well-being and lives. As such, some may wonder whether they should treat these finances like any other income, especially regarding taxes. This guide will provide a comprehensive overview of navigating tax season if you receive workers’ compensation benefits.
Is Workers’ Compensation Taxable?
The short answer is no. According to the IRS, most workers’ compensation benefits aren’t taxable. This regulation applies to any finances given to employees for medical expenses, lost wages, and disability status.
However, there are certain situations where the tax implications of your benefits may differ. For instance, if you receive long-term or short-term disability benefits through a separate insurance policy paid for by your employer, those benefits may be subject to taxation. Additionally, if you also apply for Social Security Disability Insurance (SSDI) or Supplemental Security Income (SSI) while receiving workers’ compensation, a portion of your benefits may become taxable. This occurs because the combined amount of your workers’ compensation and SSDI benefits may exceed a certain threshold, potentially leading to a reduction in your SSDI benefits, commonly known as an “offset,” which can then be taxable.
Situations Where Workers’ Compensation May Be Taxable
In addition to SSDI being taxable when combined with workers’ compensation benefits, there are also other situations when you might be subject to taxation, such as:
- Receiving retirement benefits: 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 retire early due to an injury or illness.
- Interest payments on workers’ compensation benefits: 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.
- Wages while on workers’ compensation: Many people return to work after an injury, even if they receive workers’ compensation for lost wages or medical expenses. Remember that the income you gain from returning to work, even if you’re only doing “light work,” is taxable.
Although this list includes most cases when you are subject to taxes, it’s essential to look at your taxable income to determine how much you’ll be taxed ultimately.
The Impact of Settlements and Lump-Sum Payments
Sometimes, employees seek a settlement for workers’ compensation if they believe the amount initially offered by the workers’ compensation insurance isn’t enough to compensate for lost wages or medical expenses. In these settlements, employees can decide if they would like the sum paid out in full, called a lump-sum payment, or a periodic payment they can spread throughout their lifetime. Although lump-sum payments can provide financial relief early on after a workplace injury, they can bump you into another tax bracket if you’re still getting paid your working income or receiving interest payments and retirement benefits. As a result, you would have to pay more taxes. Periodic payments, on the other hand, are less likely to move you into a separate tax bracket, as they are often smaller.
You can still receive lump sum payments and avoid further taxation. You simply have to be strategic and work with a tax lawyer to receive lump sum payments that can compensate for any lost wages and medical expenses without causing undue tax consequences.
Federal Tax Laws on Workers’ Compensation
As mentioned, if you receive SSDI in addition to workers’ compensation benefits because of a workplace injury, you may be subject to taxes, including the federal income tax. This situation arises because the Social Security Administration (SSA) imposes a cap on your combined benefits. Suppose your workers’ compensation and SSDI benefits exceed 80% of your average current earnings before your disability. In that case, the government will reduce your SSDI benefits or “offset” them to bring the total benefits down to the allowed limit.
The reduced amount of your SSDI benefits resulting from this offset is the portion that may be subject to federal taxation. Essentially, while your workers’ compensation benefits remain non-taxable, the reduction in SSDI benefits due to the offset may be considered taxable income by the IRS.
State Tax Laws on Workers’ Compensation
Every state has different tax laws and policies regarding taxing workers’ compensation benefits, especially when combined with SSDI. All 50 states don’t impose state income taxes on workers’ compensation benefits alone. That said, states with an income tax, a majority of the U.S., will impose a state income tax if your SSDI and workers’ compensation benefits exceed the allowable limit.
In states without an income tax, though, you won’t have to worry about any kind of taxing for your workers’ compensation benefits on a state level. This includes the following states:
- Alaska
- New Hampshire
- Wyoming
- Florida
- Tennessee
- South Dakota
- Nevada
- Texas
- Washington
Regardless of where you live, you should still evaluate your state’s tax regulations. For example, while New Hampshire and Tennessee don’t have a state income tax, they do have tax interest and dividend income, which could affect you if you receive interest on your workers’ compensation benefits and SSDI.
Practical Tips for Budgeting Taxes on Workers’ Compensation Benefits
If you receive SSDI and workers’ compensation benefits, it’s essential to consider your income carefully throughout the year to avoid any unexpected deductions come tax season.
Estimating Your Tax Liability
A tax attorney closest to you can help you calculate your tax liability during and after receiving workers’ compensation benefits. When meeting with them, be sure to bring documentation of all of your sources of income, including:
- Workers’ compensation benefits;
- SSDI;
- Current wages from your employer;
- Retirement benefits;
- Interest payments for workers’ compensation settlements.
You can also use an online tax calculator or software; however, this software may be less comprehensive than an actual tax professional.
Managing and Budgeting Payments
Sometimes, you can’t always control your tax situation. If you find yourself in a situation where you still have to pay taxes after receiving a lump sum payment settlement, interest payments, retirement benefits, or SSDI, it’s essential to plan for tax season. You can do that in the following ways:
- Set aside a percentage of your income: Although the exact percentage you should set aside may vary depending on your personal and financial circumstances, you should generally save 5-10% of any income you receive for your taxes, whether that includes wages, retirement benefits, or SSDI.
- Create a separate tax savings account: Establishing a separate savings account specifically for tax season ensures that you will feel less inclined to withdraw funds from it than a traditional savings account. A separate account will also keep your finances organized!
Build and adjust a budget: To save for tax season, you’ll want to create a budget to set more money aside for taxes. First, estimate your monthly income, workers’ compensation benefits, and expenses to calculate your budget. From here, you’ll want to remove any unnecessary expenses and adjust as needed.
Seeking Professional Tax and Legal Advice
If you have any uncertainty regarding tax season and you’ve received workers’ compensation benefits or any other kind of benefit, you can always seek a tax or legal expert who can either estimate what your taxes would be or provide you with alternate options to provide as minimal taxes as possible. Tax experts, in particular, may also provide budgeting tips you wouldn’t usually have.
Work with Request Legal Help to Manage Workers’ Compensation Taxes
If you’re unsure what the taxes on your workers’ compensation benefits and settlements are, contact Request Legal Help! When establishing and settling your workers’ compensation claim, our team will account for taxes and ensure that any money received doesn’t infringe on your income status. They’ll also walk you through the filing process beforehand so you won’t feel lost. Call us today to find a lawyer in your area!
Frequently Asked Questions (FAQs) About Workers’ Compensation Taxes
Is Workers’ Compensation Considered Taxable Income?
No, workers’ compensation benefits are generally not considered taxable income at the federal level. This means you do not have to pay federal income taxes on these benefits. However, there may be exceptions, such as combining workers’ compensation with other disability benefits.
Are Workers’ Compensation Benefits Taxed at the State Level?
Most states do not subject Workers’ compensation benefits to state income taxes. However, checking your state’s tax laws is essential, as variations may exist. Consulting a tax professional or your state’s tax authority can provide clarity.
Can Workers’ Compensation Be Taxed If Combined With Social Security Disability Insurance (SSDI)?
If you receive workers’ compensation and Social Security Disability Insurance (SSDI), some of your workers’ compensation benefits may be subject to federal taxation. The combined benefits might exceed a certain threshold, leading to taxable income.
Do I Need to Report Workers’ Compensation on My Tax Return?
Generally, you do not need to report workers’ compensation benefits as taxable income on your federal tax return. However, if you receive other benefits that might be taxable, such as SSDI, you may need to report the combined amount. We recommend consulting a tax advisor for accurate reporting.
Are Lump-Sum Workers’ Compensation Settlements Taxable?
Lump-sum workers’ compensation settlements are typically not taxable at the federal level. However, if the settlement includes payments for lost wages or punitive damages, those portions may be subject to taxation. It’s crucial to understand the terms of your settlement and seek legal or tax advice.
How Can I Budget for Potential Taxes on Workers’ Compensation?
While workers’ compensation benefits are usually not taxable, it’s wise to set aside funds if they may be taxed, such as when combined with SSDI. Estimating your potential tax liability and consulting with a tax professional can help you budget effectively.
What Should I Do If I’m Uncertain About the Tax Implications of My Workers’ Compensation?
If you need clarification on whether your workers’ compensation benefits are taxable, it’s best to consult a tax professional or legal expert. They can review your situation, including any other benefits you receive, and provide personalized advice.
Can I Deduct Any Expenses Related to My Workers’ Compensation on My Tax Return?
In general, you cannot deduct expenses related to workers’ compensation on your tax return. However, if you have other work-related expenses or medical costs not covered by workers’ compensation, you might be able to deduct those. Again, it’s advisable to seek professional tax advice.
What Happens If I Don’t Pay Taxes on Taxable Workers’ Compensation Benefits?
Failing to pay taxes on any taxable portion of workers’ compensation benefits can result in penalties, interest, and other consequences from the IRS or your state’s tax authority. Understanding your tax obligations and complying with them to avoid issues is essential.
Where Can I Get More Information About Workers’ Compensation and Taxes?
You can visit the IRS website, consult your state’s tax authority, or speak with a tax professional for more information. Legal experts specializing in workers’ compensation can also provide guidance tailored to your situation.
About the Author
Aaron is a professional legal writer with a B.S. in English Education from Southern Illinois University – Carbondale. He has written, published, and edited thousands of legal articles for RequestLegalHelp, which has connected over 5 million people to legal help in the United States.
With over five years of experience writing thousands of legal articles for law firms across the U.S. and Canada, Aaron specializes in covering federal, state, and city-level legal issues ranging from auto accidents to wrongful terminations.
