Does Workers’ Comp Take Taxes Out of Your Benefits?
Clarify the tax implications of workers' compensation benefits. Understand their financial impact and reporting requirements.
Workers’ compensation provides financial assistance to employees for work-related injuries or illnesses, covering medical expenses, lost wages, and rehabilitation costs. A common concern for individuals receiving these benefits is whether they are subject to income tax. This article clarifies the tax implications of workers’ compensation payments.
Understanding Workers’ Compensation Tax Rules
Most workers’ compensation benefits for an occupational sickness or injury are generally not subject to federal income tax. This exclusion applies whether the benefits are paid periodically or as a lump sum. The Internal Revenue Service (IRS) considers these payments compensation for personal injury or sickness, typically excluded from taxable income.
This non-taxable status covers payments for lost wages, medical expenses, and permanent disability. Payments to survivors of a deceased worker are also generally exempt from federal income tax. However, specific situations can make workers’ compensation payments partially or fully taxable. For instance, if a settlement includes punitive damages, that portion is taxable and must be reported as “Other Income” on Schedule 1 (Form 1040). Interest earned on a workers’ compensation award is typically taxable.
If a workers’ compensation award is part of a broader settlement with non-injury related claims, the allocation can affect its taxability. For example, payments for lost wages not directly attributable to the physical injury or sickness might be taxable. Similarly, if an individual returns to work on light duty and receives workers’ compensation payments alongside wages, the wages are taxable.
Impact on Other Benefits
Workers’ compensation benefits can sometimes affect the taxability of other government benefits, particularly Social Security Disability (SSD) benefits. The Social Security Administration (SSA) applies an “offset” rule, which can reduce SSD benefits if the combined total of workers’ compensation and SSD benefits exceeds 80% of an individual’s average earnings before disability.
When this offset occurs, the portion of SSD benefits reduced by the workers’ compensation offset might become taxable. It is important to note that it is the SSD portion that becomes taxable, not the workers’ compensation itself. IRS Publication 915 provides detailed guidance on how this interaction affects the taxability of Social Security benefits. Other disability payments or pension plans might also have specific rules regarding coordination with workers’ compensation, potentially affecting their tax treatment.
Tax Forms and Reporting
If workers’ compensation benefits are entirely non-taxable, they typically do not need to be reported as income on a tax return. This is because these benefits are not considered “earned income” under current tax laws and are generally exempt from both federal and most state taxes. Therefore, a Form W-2 or Form 1099 is usually not issued for these payments.
However, if a portion of workers’ compensation is taxable due to specific exceptions, such as punitive damages or interest, these amounts must be reported. Punitive damages are reported as “Other Income” on Schedule 1 (Form 1040). If the interaction with Social Security Disability benefits results in a portion of SSD benefits becoming taxable, the Social Security Administration issues Form SSA-1099, “Social Security Benefit Statement.” This form details the benefits received, and taxpayers use this information, often with the help of IRS Publication 915, to determine the taxable amount to report on their Form 1040. Maintaining thorough records of all workers’ compensation payments and related documentation is advisable, and consulting a tax professional is recommended for complex situations to ensure compliance with tax laws.