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Are Workers' Compensation Benefits Taxable?

Most of the time, a workers' compensation payment is tax-free. You are not required to pay taxes on the workers' compensation benefits you receive, according to the Internal Revenue Service (IRS). This is a response to the limits placed on your ability to earn a living by receiving workers' compensation benefits. You might, however, have to pay taxes in some circumstances.

For example, you must pay taxes on any income you generate if you are receiving benefits but have resumed work. Furthermore, if you receive other benefits besides workers' compensation, you may have to pay taxes in your state.

Below is an article that provides more information about tax exemptions on workers' compensation insurance.

Workers’ Compensation Coverage

Workers' compensation insurance can provide benefits to your employees if they become sick or injured while doing their job. The law governing workers' compensation insurance in your state probably also mandates that you carry coverage. The following expenses may be covered by workers' compensation:

  • Work-related injuries or accidents;
  • Illness or health condition caused by your employees’ work; 
  • Lost wages if a work-related injury or condition prevents your employees from returning to work;
  • Ongoing medical care and treatment, such as physical treatment or medications that your employees need to recover;
  • Disability benefits if a physician diagnoses your employee with a temporary or permanent injury as a result of their work; and 
  • Funeral costs if your employee loses their life due to a workplace accident or from a work-related illness. 

However, as an employee, there are certain circumstances and conditions that may render your compensation claim on these benefits invalid. Additionally, workers’ compensation does not cover every type of work-related injury or condition. Particularly, your claim might get rejected if you get injured because of one of the following:

  • Drinking alcoholic beverages while at work;
  • Using illegal drugs in the workplace;
  • Initiated a physical fight at work;
  • Self-inflicted injuries; and 
  • Not adhering to company policies and rules

If you do qualify to receive workers’ compensation benefits, you may wonder if you'll have to pay taxes on them. Generally speaking, workers’ compensation benefits are not taxable. It makes no difference whether you are receiving compensation for a slip and fall accident, muscle tear, back injury, tendinitis, or lacerations. 

In most circumstances, you won’t have to pay a single penny on taxes for your workers’ compensation benefits.

Understanding A Workers’ Compensation Policy

Workers Compensation and Employers' Liability are the two sections that typically make up a workers compensation policy. Under the Workers Compensation section,  the insurer agrees to pay whatever compensation amounts the state may require. 

In contrast to other types of insurance, workers compensation coverage does not have a cap or limit on the policy amount. Every statutory responsibility that the employer is required to pay as a result of the injury is transferred to the insurance company by the employer.

Employer’s Liability section of the policy covers an employer who is sued by an employee for work-related injury or illness that is not covered by state statutory benefits. Unlike workers’ comp, this has a financial cap.

In several other situations, employer’s liability insurance also provides coverage to an employer. A perfect example is the “third-party over suit,” in which an injured worker sues a party other than the employer and that party seeks to hold the employer reliable. 

For instance, a worker hurt while using a machine can launch a lawsuit against the maker of the machine. The manufacturer might then file a lawsuit against the employer, claiming that the employer's modifications to the machine or improper use were to blame for the accident. This liability coverage also applies when the spouse of an injured worker sues the company for loss of consortium.

Types of Workers’ Compensation Settlements

There are several types of settlements you can receive as an injured employee. They include:

Lump-sum payments

This method of payment provides all the workers’ compensation benefits that you are entitled to receive in one large payment. In some cases, depending on the sum and the way the payments are set up, lump-sum payments may be split into two or three smaller payments. Keep in mind that you will no longer be eligible for benefits or compensation after receiving payment. 

Agreement settlement

This type of settlement is composed of an agreement made between you and your employer on the amount of compensation and other terms. An oversight body or a third party witness is required to ratify an agreement settlement.

Compromise settlement

The outcome of a dispute being adjudicated by a workers' compensation judge or administrator is known as a compromise settlement. In essence, the administrator handles the workers’ compensation claims and negotiates a settlement arrangement that meets the needs of both parties. 

Structured settlement

This type of settlement provides an injured employee with a settlement arrangement that provides compensation and benefits on a long-term basis. In contrast to lump-sum payments, the injured employee will not receive the amount all at once.

When Is Workers’ Comp Taxable?

If you are an employee and also receive Social Security Disability Insurance (SSDI) or Social Security Income (SSI), you may be required to pay taxes on your workers' compensation benefits. For instance, if you:

  • Have a permanent injury at work and get SSDI and disability benefits, your workers' compensation benefits may be subject to taxation; and
  • Get injured at work and need to take time off to recover. Your lost wages are partially covered by workers' compensation, but at the same time you also receive SSI. In this case, you might be required to pay taxes on your benefits.

Keep in mind that the laws for workers' compensation vary by state. It is best to research and understand the compensation laws and regulations of your state.

Workers’ Compensation Taxes: Social Security Disability Insurance (SSDI) and Supplemental Security Income (SSI) 

If you are receiving SSDI or SSI payments in addition to your workers' compensation benefits, you may be required to pay taxes. What distinguishes the SSDI and SSI programs? It has to do with the eligibility requirements.

SSDI is a tax-funded federal insurance program. Social Security disability benefits are paid to employees each month when they:

  • Have a disability;
  • Consistently paid Social Security payroll taxes for a specified amount of time (usually five to ten years); and
  • Have limited income.

You are entitled to receive SSDI when you have enough work credits based on how long you’ve paid Social Security Taxes. However, SSDI benefits are taxable.

On the other hand, SSI is a welfare program that provides financial aid and healthcare on a monthly basis to qualified individuals who need it. In order to be eligible, you must be:

  • Over the age of 65 years old;
  • Blind or disabled;
  • A U.S. citizen residing within the country; and
  • On a limited income.

Unlike SSDI, you may still receive SSI benefits and compensation without having ever worked or don’t have enough work credits. Also, SSI payments are not taxable. 

Social Security Disability Offset

Even though, generally speaking, workers’ compensation payments are non-taxable, there is still an exemption. 

If you are injured worker, you still have to pay taxes if you also receive Social Security Disability Insurance (SSDI) on top of your workers' compensation. Your benefits may be reduced or "offset" if the combined amount of your SSDI and workers' compensation benefits is greater than 80% of your pre-disability average monthly income.

Your workers' compensation benefits would be taxed equivalent to the amount that Social Security deducts from your SSDI payments. For instance, if your SSDI benefits were reduced by $500, then $500 of your workers’ compensation benefits are now taxable.

However, the majority of injured employees who receive both SSDI and workers' compensation benefits do not earn enough to be required to pay federal taxes.

Workers’ Compensation  Benefits Exempted From Tax Payments

You are not required to pay taxes on any workers' compensation benefits you are eligible to receive. You won't be required to pay taxes as long as you are receiving your benefits from your workers' compensation coverage. The benefits you receive from other assistance programs while receiving workers' compensation benefits, however, do not fall under this category.

For instance, you will still be taxed on a number of retirement benefits you receive while receiving workers' compensation. A portion of your benefits can be taxed if you receive more compensation than is permitted in comparison to your pre-injury salary. 

Benefits and compensation from your workers’ compensation insurance alone is not taxable. However, you may end up paying taxes if you receive other benefits from other programs on top of your workers comp.

If you have submitted your VA claims and have been approved, find out when can you expect to receive your first VA disability check in this article by Disability Help.

Cheri Hermanson
Cheri leads our team of writers in producing the best quality content there is regarding society and disability, most especially those that helps ease the quality of life for our differently-abled loved ones.
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