Are Workers’ Comp Benefits Taxable?

How Does Workers' Comp Work?

Workers' compensation is a type of insurance that pays a cash benefit to employees who've been injured on the job. Most jobs fall under individual states' workers' comp laws, but there are also federal programs that apply to federal workers.

To receive workers' comp benefits, an injury or illness must be work-related. Workers' comp benefits typically cover:

• Medical treatment
• Ongoing care
• Lost wages
• Disability benefits
• Funeral expenses

Typically, workers don't have to prove negligence on the part of their employer in order to receive workers' comp benefits. In exchange for providing this benefit, employers may receive some legal protections from injury-related lawsuits.

Are Workers' Comp Benefits Taxable?

In general, you don't have to pay taxes on your workers' comp benefits, as they're not included in your regular wages. According to the IRS, workers' comp benefits "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."

Are Other Disability Benefits Taxed?

Though workers' comp benefits generally aren't taxed, they can affect your taxes in other ways—especially if you receive additional benefits and payments related to your disability.

Reimbursed medical expenses, Social Security Disability Insurance (SSDI), Supplemental Security Income (SSI) benefits, state disability benefits and retirement benefits can all have tax implications. Here's how:

Reimbursed Medical Expenses

Reimbursements for medical expenses generally aren't taxable, but they can have some implications on your taxes:

• You can't deduct medical expenses reimbursed by insurance.
• Advanced reimbursements for future medical expenses are considered income.
• Reimbursements for medical expenses incurred before your employer's plan was established are included in income.
• Unused reimbursement amounts paid to you as cash or other benefits are also considered income.

Learn more: Are Medical Expenses Tax Deductible?

SSDI and SSI Benefits

Federal disability benefits may be available if you have a qualifying disability and are unable to work for 12 months or longer.

• SSDI provides Social Security benefits to disabled workers who have paid enough Social Security payroll taxes to qualify and have limited income. SSDI may be taxable under the same income rules that apply to Social Security retirement benefits.
• SSI provides monthly payments to qualifying blind or disabled adults and children with limited incomes and resources. SSI benefits aren't taxable.

Another important caveat is that the combined total of your SSDI or SSI benefits and workers' compensation benefits cannot exceed 80% of your average income before becoming disabled. If they do, your SSDI or SSI benefits will be offset to meet the 80% threshold, and your offset amount may be taxable. When your Social Security benefit is reduced because of workers' comp, that offset amount is treated as Social Security income and may be taxable.

Example: Say your pre-disability income was $2,500 a month and workers' comp pays you $1,300. An additional SSDI payment of $1,200 would give you 100% of your regular income. Your SSDI payment would be reduced to $700 to meet the 80% cap ($2,000). Additionally, $500 of your workers' comp payments—the $500 offset—might be taxable as well.

State Disability Benefits

Currently, Puerto Rico and five states offer short-term disability benefits: California, Hawaii, New Jersey, New York and Rhode Island. Generally speaking, these programs are designed to cover people who are not receiving workers' compensation benefits. State disability benefits are taxed (or not taxed) differently in each state. Check with your state's taxing authority or your tax advisor if you collect state disability benefits.

Retirement

If you decide to retire early after becoming disabled on the job, check with your retirement plan administrator to learn more about the tax implications. Although rules vary depending on the type of retirement plan or funds you have, workers' comp tax exemptions don't apply to retirement benefits, even if you retired because of a workplace sickness or injury.

How Can I Manage My Finances While on Workers' Compensation?

Regardless of the extent of your injury and the duration of your break from work, your finances are almost certain to look different while receiving workers' comp. Ideally, workers' comp covers medical expenses and lost wages due to an accident or injury on the job, but a long-term disability will require you to rethink your finances well into the future. Here are some tips to help you stay on top of your money:

• Budget for your changing income. Your income will likely shrink during time off work, so you'll want to update your budget accordingly. If you can, cut out discretionary purchases or negotiate the cost of fixed expenses. It's OK if you end up needing to dip into savings, but plan as much as possible for any long-term budget constraints.
• Consider your future employment. If your recovery isn't quick or complete, you may need to consider other work options. Maybe your employer can offer a less physically demanding position or part-time hours. You may also be eligible for training and education benefits if you're unable to return to your previous role.
• Look for additional benefits. You may qualify for additional benefits, such as SSI, SSDI or other state or local disability benefits. You might even consider an early retirement if your return to work is uncertain. Federal and state taxes on disability benefits can be complicated, so plan on doing some tax planning if you receive any of these additional benefits.

Frequently Asked Questions

The Bottom Line

Workers' comp benefits aren't classified as income and, therefore, aren't generally taxable. Workers' comp benefits can have tax implications if you receive additional benefits related to your injury or illness, however. If you receive additional medical reimbursements, SSDI or SSI, state disability insurance or retirement benefits, you may want to consult a tax advisor to help make sense of your tax liabilities.