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  • Nick Burgess

Are Workers' Compensation Benefits Taxable?

The following is for education and entertainment purposes only, and should not be considered financial advice. Please do your own research and contact a licensed tax professional for any individual questions. Links below may contain affiliate link which generate a small commission for the site at no cost to you.

 

What Is Workers' Compensation?

Workers' compensation is a type of insurance program that provides financial compensation and medical support to employees who suffer a work-related injury or occupational sickness. A workers' compensation claim is designed to help employees cover expenses related to medical bills, medical treatment, lost wages, and rehabilitation. The program is designed to provide an injured worker with a faster and more streamlined process for resolving workers compensation claims, as compared to traditional personal injury lawsuits.

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In the United States, while the Federal Employees Compensation Act does cover some workers, generally workers' compensation is not a function at the federal levels. Workers' compensation cases are resolved by a state-administered program that is funded by employers through insurance premiums or self-insurance. Each state has its own specific laws regarding workers' compensation, but in general, the program provides a no-fault system for resolving workplace injury claims. This means that an employee does not have to prove that the employer was at fault for the injury in order to receive benefits.

How Workers' Comp Is Taxed

The tax treatment of workers' compensation benefits can vary depending on the type of injury or illness that the employee is receiving benefits for, as well as the state where the employee is located. Generally, workers' compensation benefits are considered taxable income by the Internal Revenue Service (IRS). This means that employees who receive workers' compensation benefits must report the payments as income on their federal taxes and may owe taxes on the payments.

The taxability of workers' compensation payments is based on the principle that workers' compensation is meant to replace lost wages and is therefore considered to be compensation for services rendered. As such, workers' compensation benefits are generally considered to be taxable income, just like regular wages or salary.

In some cases, workers' compensation benefits may also be subject to Social Security and Medicare taxes, also known as Federal Insurance Contributions Act (FICA) taxes. The FICA taxes are automatically withheld from an employee's paycheck, but they may also be withheld from workers' compensation payments if the payments are considered taxable income.

It is important to note that the taxability of workers' compensation payments can vary depending on the state where the employee is receiving the benefits. Some states have specific laws that exempt workers' compensation payments from state income tax, while others may tax the payments. Additionally, some states have specific rules for taxing permanent injuries that differ from the rules by IRS publication.

For example, some states law dictates that portions of workers' compensation payments are exempt from state income tax if the payments are for a permanent injury. The amount of the exemption can vary depending on the state and the specifics of the injury. In these states, employees may still owe federal income tax on the workers' compensation payments, but the state income tax may be lower or nonexistent.

Employees who receive workers' compensation benefits should keep detailed records of their payments, including the amount received and the reason for the payment. They also need to note whether the settlement agreement they receive is a lump sum payment, or is a payment administered over a length of service. This information is important for accurately reporting the payments on their federal and state tax returns, especially if the payments fall over two separate tax years.

Social Security Disability Insurance

Social Security Disability Insurance (SSDI), is a Social Security Administration program meant to pay disability when a Social Security-eligible person is injured. SSDI benefits can be extremely helpful as it provides supplemental security income, but it's also rife with challenges if you have other financial support. According to the SSA, your social security disability benefits will not be affected if you receive other select other public benefits, such as Supplemental Security Income or benefits from the Veterans Administration (VA), or private benefits like retirement plan benefits, private pension or personal retirement income. However, if you receive workers compensation benefits or a workers' compensation settlement from your company, then you could be in for a world of (further) hurt.

Social Security benefits, including SSDI payments, are meant to make up your lost/previous income, but only up to 80% of that income. If you have other social security disability payments, workers' compensation lump sum settlements or something similar, then those will affect the full amount of the social security benefit you could receive from the SSDI program.

Conclusion

In conclusion, workers' compensation is a type of insurance program that provides financial and medical support to employees who become injured or ill as a result of their job duties, but it can be incredibly complicated. The workers' compensation system is designed to provide employees with a faster and more streamlined process for paying medical expenses, and was essentially meant to bypass the insurance company fight that could come with claims like these.

Workers' compensation payments are generally considered taxable benefits by the IRS and may be subject to Social Security and Medicare taxes. The taxability of workers' compensation payments can vary depending on the type of injury or illness, the state law where the employee is located, and the similar law and regulations that apply to the employee's situation. Additionally, employees should consult with a tax professional or financial advisor to determine the tax implications of their specific situation. A tax professional, as well as appropriate professional legal advice, can help employees understand the tax laws and regulations that apply to their workers' compensation benefits and can provide guidance on how to report the payments on their tax return.

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