Do You Have to Pay Taxes on Workers Compensation Benefits or Settlements?
All Workers Comp Payments are Tax-Free at the State and Federal Level
Benjamin Franklin, one of the Founding Fathers of the United States, said this in a letter discussing the Constitution, “in this world, nothing is certain except death and taxes.”
And anyone who has received a paycheck knows Franklin was right. Federal, state, and FICA (Social Security and Medicare) taxes are withheld from your gross earnings, reducing how much money you take home.
Fortunately, workers comp is an exception to the rule.
For example, you do not have to pay taxes on the following types of workers compensation benefits:
- Weekly workers comp payments for Temporary Total Disability (TTD) or Temporary Partial Disability (TPD)
- Compensation for permanent partial disability (loss of use/permanent impairment, amputation, or scarring and disfigurement)
This article explains why and discusses common tax issues in workers compensation claims, including cases brought under the Longshore and Harbor Workers Compensation Act (LHWCA).
Keep reading to learn more.
And if you have questions about workers compensation laws in Virginia, call me at (804) 251-1620 or (757) 810-5614 or complete this online contact form.
My law firm wants to help you figure out how to get as much money as possible for your injury, illness, or disability.
Publication 525: What Does the IRS Say About Workers Comp and Taxes?
The Internal Revenue Service (IRS) publishes Publication 525, Taxable and Nontaxable Income.
This document “discusses many kinds of income and explains whether they are taxable or nontaxable.”
One section concerns workers compensation payment.
And here is what the IRS says:
Amounts you receive as workers compensation for an occupational sickness or injury are fully exempt from tax if paid under a workers compensation act or a statute like a workers compensation act. The exemption also applies to your survivors. The exemption, however, doesn’t apply to retirement plan benefits you receive based on your age, length of service, or prior contributions to the plan, even if you retired because of an occupational sickness or injury.
Let’s take a closer look at this section.
Are Workers Comp Wage Loss Benefits Taxable?
No.
You do not have to pay taxes on indemnity payments for total or partial wage loss.
Is Compensation for Permanent Loss of Use (Permanent Partial Disability) Taxable?
No.
You do not have to pay taxes on amounts you receive for permanent loss of use of the injured body part.
Do I Have to Pay Taxes on the Value of the Medical Treatment the Insurer Paid for My Occupational Injury or Illness?
No.
The IRS says you can receive income as money, property, or services.
But you do not have to pay state or federal taxes on the value of medical services and expenses paid by the insurer for your workplace injury.
Will I Owe Taxes on My Workers Compensation Settlement?
No.
Many workers comp cases end with a compromise and release agreement.
Fortunately, you do not have to pay taxes on this lump sum payment, even when it includes a cash buyout of future medical expenses.
Are My Wages Taxable if I Return to Light-Duty Work After Receiving Workers Comp Payments?
Yes.
Publication 525 addresses taxation when you return to light-duty work after receiving payments under a Workers Compensation Award Letter.
And the IRS says that earnings from light-duty work are taxable as wages.
Here is an example:
Suppose you work in construction and suffer a torn rotator cuff and herniated disc when you fall from a ladder.
Initially your orthopedic surgeon disables you from all work while you recover from arthroscopic surgery and spinal fusion. During this period, the insurer pays temporary total disability.
Several months later, your doctor declares that you have reached maximum medical improvement (MMI) for the shoulder and lower back injury and refers you for a functional capacity evaluation (FCE). That FCE determines you can do sedentary work only.
The pre-injury employer gets a copy of the FCE and offers an administrative position allowing you to sit and avoid lifting.
But you earn less in this position.
In this scenario, the wages paid by your employer for the sedentary job are taxable.
However, you will be entitled to temporary partial disability to cover two-thirds of the difference in your pre- and post-injury wages.
You do not have to pay taxes on these workers comp benefits that cover the difference in earnings.
Are There Exceptions to General Rule that Workers Comp Amounts are Nontaxable?
The IRS never considers workers comp benefits or settlements as taxable income.
But you may owe taxes on other benefits received due to the effect workers comp payments have on those benefits.
The most common example for injured employees involves the workers compensation offset of Social Security disability insurance (SSDI) benefits.
In some cases, the Social Security Administration (SSA) will reduce a person’s SSDI payments so that the amount of the weekly workers comp benefits and the disability payments do not exceed 80 percent of your average current earnings.
The amount by which the SSA reduces your monthly SSDI payment is called the workers comp offset. And the IRS considers this amount as taxable income.
But before you start to worry about a big tax bill, remember that you may not be required to pay federal taxes if this amount is under the applicable threshold for the year in question.
In addition, including specific language in your workers comp settlement papers will allow you to reduce or even eliminate the offset, reducing your tax exposure.
Is My Work-Related Disability Retirement Benefit Subject to Income Taxes if I am Disabled Because of a Workplace Injury?
Yes, part of your work-related disability benefit is subject to federal and state income taxes.
For example, suppose you work for a local government entity and sustain a head injury resulting in a concussion.
Instead of improving, your symptoms worsen, and your neurologist diagnoses post-concussion syndrome. And eventually, your medical condition forces you to retire.
In this scenario, you will likely qualify for service-connected disability retirement benefits through the Virginia Retirement System (VRS).
Although your entitlement comes from a workers comp injury, the work-related disability benefit based on the VRS formula amount is subject to income taxes for any amount paid over the guaranteed benefit.
Therefore, work-related disability retirement payments are treated differently than workers comp payments for tax purposes, even though the underlying cause (the accident) is the same.
Are Other Sickness and Injury Benefits Taxed?
A catastrophic workplace injury or the diagnosis of an occupational illness may result in eligibility for other benefits.
Let’s examine whether you must pay taxes for these other payments for sickness or injury.
Accident or Health Insurance Policy Payments
Benefits you receive under an accident or health insurance policy are nontaxable if you or your employer paid the premiums.
Black Lung Benefit Payments
Black lung payments are similar to workers comp benefits. Therefore, they are not taxable in most cases.
Federal Employees’ Compensation Act (FECA)
Federal government employees do not qualify for workers compensation under state laws.
Instead, you must pursue payment under the Federal Employees’ Compensation Act (FECA).
Usually monies received under FECA are not taxable.
But there is an exception. You must pay taxes on amounts received as a continuation of pay while you wait for a decision on the claim (up to 45 days).
Employment Law Claims
Generally the IRS does not consider damages recovered from an employment-related dispute as a recovery for a personal physical injury.
Therefore, in most cases, your taxable gross income will include monies from an employment-related judgment.
No-Fault Auto Insurance Policy
Some auto insurance policies pay benefits for loss of income or earning capacity due to injuries in a car crash, regardless of fault.
Examples of these policies include Med Pay and Personal Injury Protection (PIP).
Personal Injury Damages
Payment for a tort or tort-like injury is nontaxable.
The IRS views the remedies available under the applicable statute or common law to determine whether your claim is tort-like (such as a negligence law claim).
Therefore, you do not have to pay taxes on a court order or award (including settlement) if you show you recovered the monies for personal physical injuries or physical sickness or as reimbursed expenses for medical treatment for emotional distress.
So, for example, monies from an auto accident settlement are usually tax-free.
You may, however, have to pay taxes for the following items:
- Interest the defendants must pay.
- Damage awards for emotional distress unaccompanied by a physical injury or sickness. For example, you must pay taxes on verdicts or settlements for defamation (libel and slander).
- Punitive damages
- Back pay and damages for emotional distress received for a claim under Title VII of the Civil Rights Act of 1964
Railroad Sick Pay
Payments you receive as sick pay under the Railroad Unemployment Insurance Act are taxable unless you receive them for an on-the-job injury.
Reimbursement for Medical Care
Reimbursement for medical care is not taxable directly.
But these payments may reduce your medical expense deduction when you file income tax returns.
Qualified Indian Health Care Benefit
You do not pay taxes for benefits provided by the Indian Health Service, including reimbursements you received for medical care expenses provided by an Indian tribe.
Helping Injured Workers Put More Money in their Pockets
The critical number in tort litigation is how much you receive with a specific option.
And we are ready to pursue all income sources available for your injury and disability so that you get more money in your pocket.
Call now for a free consultation with one of Virginia’s best personal injury lawyers: (804) 251-1620 or (757) 810-5614.
We will explain your options and how federal or state income taxes apply.
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