Workmans' compensation benefits (often dubbed workers’ comp) have their own tax treatments — but how are these funds treated differently than ordinary income in the U.S.? The Internal Revenue Service (IRS) lays it all out, but the details can be difficult to sift through.
To help you understand the rules around your workers' comp, let’s uncover the tax treatment so you know what you will receive or owe.
Is workmans' comp taxable?
In general, workmans' compensation benefits aren't taxable at the state or federal level. This is because workers’ comp funds are considered to be from the government (even though employers are required to carry workers’ comp insurance). Taxing workers’ comp would just put that same money back in Uncle Sam’s pocket.
It’s worth noting that each state has its own workers’ comp requirements, but the general rule of thumb is that benefits aren't taxed. Naturally, there are exceptions, so it’s important to be aware of any reason your funds could be taxed.
Receiving Social Security benefits? You may be taxed on workers' compensation.
Anyone who receives Social Security Income (SSI) or Social Security Disability Income (SSDI) in addition to workers' comp may be required to pay a tax on some benefits.
There’s a simple equation for you to determine if you’ll be taxed, and by how much. Calculate your average earnings prior to becoming disabled. If your workers' comp and Social Security benefits combined exceed this threshold, any excess is deducted as a benefit offset.
This offset could be considered a tax in and of itself, though the value depends on your previous income and the value of your combined benefits. But that’s not the only tax. If you do receive an offset, that same dollar value of your workers’ comp becomes taxable.
At times, workers' comp can be taxable.
Say you earned $60,000 per year prior to becoming injured on the job. If you take 80 percent of that value, you can earn up to $48,000 per year in benefits without having an offset deducted from your benefits.
You receive workers’ comp and SSDI, which gives you a combined $51,600 per year, or $3,600 over the limit. That’s $300 too much per month, so $300 is subtracted from your benefits per month.
Plus, you are now taxed on $300 of the social benefits that you receive.
It’s worth mentioning that this circumstance is extremely rare. Most people don’t have to worry about earning more in benefits than 80 percent of their previous income. Because of this, owing taxes on your workers' comp isn’t likely.
However, it’s important to be aware of any caveats that could change this.
Working light duty while on workers' comp? Your income is taxable.
Some people work part time on light duty while recovering from an injury or to earn money while still receiving workers’ comp benefits. Any income from this incurs ordinary income taxes, but it doesn’t impact the taxation of your workers’ comp.