Workers' Comp Basics: Are WC benefits taxable?
According to the IRS, no matter how workers’ compensation wage loss payments are paid out — weekly or in a lump sum settlement — workers' compensation is not taxable.
The same applies to lump sum payments to survivors. There are only two minor exceptions to this, which we will cover shortly.
According to IRS Publication 907, "The following payments are not taxable … Workers" compensation for an occupational sickness or injury if paid under a workers' compensation act or similar law."
Also, employees who receive workers' compensation will not get a W-2 statement, so it's not necessary for them to include this information when filing taxes.
The IRS does not consider workers' compensation payments "earned income." Not taxing these payments makes up somewhat for the fact that wage loss payments are substantially less than what an employee's earned income would be in most cases.
Two Exceptions
One exception, where taxes play a part, is if the recipient simultaneously receives Social Security Disability and Workers' Compensation. This may trigger a tax notification on the Social Security Disability income.
The website at Disability Benefits Center advises workers who receive both that "the one effect which collecting Workers' Compensation does have on SSDI is that the total income you receive from Workers' Compensation and SSDI cannot be more than 80% off your previous income."
"If the money you are receiving from Workers' Compensation and the money you are entitled to through SSDI are greater than 80% of your prior income, the SSA will deduct enough money from your SSDI entitlement to bring your total under 80%. If your Workers' Compensation runs out while you are still collecting SSDI, notify the SSA and they will adjust your SSDI benefits appropriately."
This can get complicated so workers in this situation should consult a qualified tax expert.
The other exception is when wages are received while working in a modified role during recovery. Those wages will be taxed, but the wage loss benefits being received during this time will not be.
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Workers' Comp Basics: Are WC benefits taxable?
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