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Are Workers' Compensation Settlements Taxed by the IRS?

Workers’ comp is generally not taxable, but there’s an exception with social security

If you are receiving worker’s compensation benefits for a work-related injury, you might be wondering if that money can be taxed.

Generally, the answer is “no.” Workers’ compensation payments are typically not considered taxable income. However, there’s an exception: if you receive social security disability benefits in addition to workers’ comp, some of your workers’ comp could be taxed.

It’s important to be aware of how your workers’ comp could be impacted depending on the benefits you receive. This article will cover the main issues with taxes and workers’ comp and point to further legal resources.

What Is Workers’ Compensation?

What happens if you are injured as a result of working for your employer? Can you expect any financial assistance for missed work or medical expenses?

Workers’ compensation is an area of law that addresses these questions.

“Workers’ compensation is a system that is usually developed by governmental entities,” says Texas workers’ compensation attorney Matthew Lewis. “There are workers’ compensation systems nationally, and each state has its own workers’ compensation laws as well.”

The purpose of workers’ compensation laws is to “provide medical treatment and income replacement benefits to employees who get hurt on the job.”

Generally, workers’ compensation law:

  • Lays out the benefits that employees are entitled to if they suffered a work-related injury
  • Lays out the rules and procedures for claiming these benefits

“All states have some type of income replacement benefit and some kind of medical benefit so that people can get treatment and get back to work,” says Lewis. “Many states will also have some type of impairment benefit to compensate the employee for any permanent—beyond the immediate—timeframe.”

Workers’ compensation cases are not lawsuits, although they do involve a litigation or dispute resolution process. There can be multiple stages to a workers’ comp claim, each stage having strict deadlines. Since the process of pursuing a claim can be complicated, getting advice from a workers’ compensation attorney or someone familiar with your state’s workers’ comp system is advisable.

Workers Comp Is Generally Tax Exempt

Workers’ compensation benefits are generally not taxable by the Internal Revenue Service (IRS).

As the IRS publication on taxable and nontaxable income says, “Amounts you receive as workers’ compensation for an occupational sickness or injury are fully exempt from tax if they’re paid under a workers’ compensation act or a statute in the nature of a workers’ compensation act.”

Whether you receive your workers’ comp settlement amount on a monthly basis or as a lump sum payment, the amount is not taxable. This tax exemption also applies to survivors who are beneficiaries of workers’ comp benefits.

Monthly Payments Versus Lump Sum

Depending on your state’s laws, workers’ compensation settlements might be paid out in a lump sum or on a monthly or weekly basis. Lewis says every state is slightly different. “For instance, in Texas, you can only get weekly benefits for lost wages. Other states will have their own payment plans.”

Some things Lewis suggests considering when choosing between a lump sum or a monthly payment might be:

  • The amount you are getting
  • The bills you have to pay—for example, can you live off a weekly check? Do you need a monthly check in order to pay the rent?

“Your individual situation with respect to bills and the amount you will receive both come into play in the consideration of how to accept payment,” Lewis adds.

An Exception: Social Security Disability Benefits

“When social security comes into play,” Lewis says, “there’s an exception” to workers’ comp being nontaxable.

The Social Security Administration (SSA) offers two kinds of disability benefits:

  • Social Security Disability Insurance (SSDI). SSDI is designed to assist individuals with disabilities. Like social security retirement benefits, SSDI is available to people who “paid into” the system through their lifetime payroll tax contributions. Learn more about SSDI benefits by reading this article.
  •  Supplemental Security Income (SSI). Functioning as a safety net, SSI benefits are designed to help individuals with disabilities who do not qualify for SSDI (due to not having contributed enough) and have limited means. Learn more about SSI benefits by reading this article.

The exception arises when:

  • An employee gets disability payments through SSDI or SSI in addition to worker’s comp
  • The combined benefits from workers’ comp and SSDI or SSI are greater than 80% of the employee’s average current earnings (ACE)

If this happens, the SSA will initiate a procedure called “workers’ compensation offsetting.” Offsetting means that your social security benefit is reduced because of the workers’ comp payment.

For example, say your average current earnings are $2,000 per month. 80% of $2,000 is $1,600. But say you get:

  • $1,000 per month from workers’ comp
  • $700 per month from SSDI

That’s a total of $1,700 per month from workers’ comp and SSDI combined. In order to bring your total amount to 80% of your earnings ($1,600), the SSA will deduct $100 from your SSDI payments.

And here’s the tax catch, Lewis says: “You still have to pay income tax on the amount that would have been attributed to social security if it had not been offset by workers’ compensation.” Even though the $100 is considered workers’ comp because of offsetting, it is still part of the taxable social security benefit.

However, you only have to pay taxes on the offset amount if you make enough each year to pay federal taxes. You can use this fact sheet from the SSA to figure out if you make enough money to have to pay.

Questions for an Attorney

The process for filing a workers’ comp claim can be very complicated. If you are pursuing workers’ comp or have questions about taxes on your benefits, consider speaking with a workers’ comp attorney about your claim.

Many attorneys provide free consultations to prospective clients. These consultations allow the attorney to hear the facts of your case and for you to determine if the attorney meets your needs.

To see whether an attorney or law firm is a good fit, ask informed questions such as:

  • What are your legal fees, and what billing options do you offer?
  • What is your experience as a workers’ comp attorney?
  • What are the rules on my pension plan?
  • How will returning to work impact my pension or social security benefits?

You can visit the Super Lawyers directory and use the search box to find a lawyer based on your legal issue or location. 

Look for a workers’ compensation attorney to help with workers’ comp issues.

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