Are Workers’ Comp Benefits Taxable?

Do I Have to Pay Taxes on My Workers’ Comp Benefits?

Broadly speaking, you do not have to pay federal or state taxes on workers’ compensation benefits. They are not included in your regular wages.

Most states require employers to carry workers’ compensation insurance for their employees. Workers’ compensation provides benefits for workers who suffer an injury or illness on the job. The accident or illness must be work-related; workers’ comp is not for an employee who gets in a car accident on the way to work, for example. Here’s what workers’ comp typically covers:

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

Are Other Disability Benefits Taxed?

That said, receiving workers’ comp benefits can affect your taxes in other ways, especially if you receive additional benefits and payments related to your disability. Employees who receive workers’ comp benefits should be aware of possible tax implications if they receive reimbursed medical expenses, Social Security Disability Insurance (SSDI) or Supplemental Security Income (SSI) benefits, state disability, or retirement or unemployment benefits. Here’s how these play out:

Reimbursed Medical Expenses

Reimbursements for medical care are generally not taxable. However, medical reimbursements may affect your taxes under the following conditions:

• Medical reimbursements are not included in your medical expense deduction, if you take one.
• An advance reimbursement for future medical expenses is 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.

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 are not taxable.

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.

Here’s an 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, 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 and Unemployment

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, your retirement benefits may be taxable.

If you lose your job because you are unable to do your work as a result of a work-related disability, you may be eligible for unemployment. Note that unemployment benefits only apply if you no longer have a job, not if you expect to return to your job. Unemployment benefits are generally taxable.

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

An injury or illness that limits your ability to work is also likely to disrupt your finances. While workers’ comp can help cover medical expenses and lost wages while you recover, a serious injury or disability may require you to rethink your finances in both the short and long term:

• Budget for your changing income. Map out a plan using your expected income and regular expenses while you recover. Make additional plans for the long term if your disability is extended or permanent. If you can, cut back on expenses.
• Consider your work options. When can you return to work? Are you eligible for retraining or education benefits if you aren’t able to return to your previous line of work? Can your current employer offer you a different position while you are recovering or permanently?
• Look for different types of benefits. Your long-term strategy may include retiring early or collecting SSDI, SSI or other state and local disability benefits. Federal and state taxes on disability benefits can be complicated, so plan on doing some tax planning if you receive disability benefits.
• Keep an eye on your credit. It’s easy to delay or miss a payment after experiencing a major accident or illness. If you’ve been offline temporarily, check your credit card and loan accounts to make sure your payments are current. Consider checking your credit report as well, to make sure nothing has slipped through the cracks.

The Bottom Line

Although workers’ compensation benefits aren’t taxable, you may want to consider taxes in your long-term planning if you need to tap additional benefits while you recover from an extensive injury or illness, or cope with a long-term disability. And though workers’ comp benefits shouldn’t add to your tax bill, you may want to double-check the information on your tax return to make sure your reported income is accurate after receiving workers’ comp benefits.