Workers’ compensation is designed to help you. It covers lost wages and medical costs. However, what many people don’t realise is that it may have tax implications, and when you’re already recovering from a workplace injury, the last thing you want is a surprise tax bill.
Fortunately, most of the time, you don’t owe tax on workers’ comp. However, there are a few exceptions to the rule. It’s important to understand how it all works so you don’t end up with a nasty financial shock. If you’re receiving other benefits, you need to be aware of how this may affect the tax you owe. In this article, we’ll go over the finer details to help you stay on the right side of the IRS.
When Workers’ Comp is Tax-Free
Workers’ compensation benefits are almost always tax-free, so the likelihood is that you don’t need to worry. Generally speaking, you won’t be taxed on regular wage replacement payments, medical reimbursements, or permanent disability awards. These are all excluded under Section 104(a) of the Internal Revenue Code.
You also don’t need to report these payments on your federal return. However, workers compensation taxes may apply if you’re receiving money through a channel other than a workers’ compensation program. For instance, things may work slightly differently if you’re getting payments from your employer’s sick pay plan.
What If You Receive Social Security?
If you’re receiving Social Security Disability Insurance (SSDI), things get a bit more complicated. There’s a rule called offset provision which means that if your SSDI and workers’ comp benefits exceed a certain limit, the Social Security Administration will reduce your SSDI. The amount of that reduction may be taxable. Still, your workers’ comp isn’t taxed directly, but receiving it may have implications for other benefits.
Settlements and Lump Sum Payments
If part of your settlement includes interest, emotional distress that’s unrelated to injury, or punitive damages, that portion may be taxable. The rest of it that covers things like medical costs, lost wages, or disability is usually tax-free. For example, let’s say you receive a lump sum which you put in a high-interest savings account. The interest would need to be reported. Ultimately, it depends how the settlement is structured. Read the terms carefully and get legal advice where needed.
What About Your Tax Return?
Normally, you don’t need to list workers’ comp payments on your tax return. However, some circumstances may change that. For example, if you worked part-time during your recovery, earned interest on a settlement, or received SSDI, it’s a good idea to check with a tax adviser. The IRS doesn’t have a standard tax form for workers’ compensation. However, Form 1040 (U.S. Individual Income Tax Return) requires information on SSDI offsets and other situations that may affect the details of your return.
Endnote
It’s likely you don’t owe taxes on workers’ compensation benefits. However, it’s not always the case. If you received a settlement, SSDI, or you have a mixed income, it’s wise to double-check. It’s always better to be safe than sorry when the IRS is involved. If you’re in doubt, speak to a tax professional or legal advisor. A quick check now will let you know where you stand, and save you stress further down the line.