Employers with employees are likely required to carry workers’ compensation insurance to cover injured workers. Workers’ compensation laws vary by state, but all except for Texas require employers with over a certain number of employees to have this insurance. In Texas, workers' comp coverage is voluntary for most employers.
If you ever need to file a claim, you’ll probably have many questions about your workers’ comp benefits. One of the most popular ones is if these benefits are taxable. We’ll answer that question here, along with exceptions to the rule, whether you have to report workers’ compensation income on your tax return, and more.
What to Know about Workers’ Compensation Insurance
Workers’ compensation programs are state-run, with each state setting its own laws, filing deadlines, premiums, and benefits. The state also decides if the state, state-run agencies, and private insurance companies can sell and handle policies.
Workers’ compensation can pay for lost wages resulting from work-related accidents, injuries, illnesses, and more, as well as death benefits like funeral costs. If you have an eligible workers’ comp claim and your employer carries workers’ comp insurance, there are some key actions you must take to receive benefits:
- Report your injury quickly: Although deadlines vary by state, you should report your injury to your employer as soon as possible. In states like Colorado, you only have four working days to report your injury in writing if you want to keep your full benefits eligibility.
- File your workers’ comp claim: Every state has a deadline for filing workers’ comp claims, typically between one and two years. The faster you file, the faster you can start receiving your benefits. Speak to your employer or your Human Resources (HR) department to fill out the necessary paperwork.
- See a medical provider: Your employer may ask you to see a doctor or specialist before triggering your workers’ compensation benefits. Social Security may also ask you to periodically visit a healthcare provider to preserve your workers’ comp benefits. Some states allow you to choose your own doctor for these visits.
Remember that your claim may be denied if your accident happened while driving home or running personal errands outside. Likewise, denials can happen with incomplete applications, when the documented injuries and accident reports don’t match, and more. If your claim is denied, you’ll receive a letter with the exact denial reason, information on possibly appealing, and appeal deadlines.
What if your employer isn’t required to carry workers’ comp insurance and you’re hurt at work? Your best recourse may be to apply for your state’s uninsured employer fund (if it has one) or to work with a personal injury law firm to file a lawsuit. Lawyers typically offer a free consultation and only require payment if they win your case.
Is Workers’ Compensation Taxable by the IRS?
In general, workers’ comp benefits aren’t taxable, whether that’s your bi-weekly payments or your workers’ comp settlement. While it’s technically income in the sense it’s money you receive, the Internal Revenue Service (IRS) doesn’t count workers’ compensation benefits as taxable income.
The IRS Publication 525 states that “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.” This policy makes sense, considering that any lost wages you receive from workers’ comp are already at a reduced rate—typically 66.66 percent of your current earnings.
Exceptions to the Rule: Workers’ Comp Taxes on SSDI
While workers’ comp benefits are generally tax-free, there is one instance where you may have to pay taxes. SSDI provides financial assistance to people with disabilities if they meet the program’s qualifications. Per the IRS, if you receive Social Security Disability Insurance (SSDI) and your benefits are reduced because of your workers’ compensation benefits, then the dollar amount your SSDI was reduced by is probably taxable. That amount is essentially considered to be the SSDI portion of your workers' comp benefits.
Not every public benefit can impact your Social Security benefits. While workers’ comp may, others like Supplemental Security Income (SSI) and Veterans Administration benefits do not.
It’s also worth noting that even if you retired because of a work-related injury or sickness and are receiving retirement benefits from Social Security, you would still have to pay taxes on your retirement benefits. The tax exemption applies only to workers’ compensation benefits.
How Do SSDI and Workers Comp Work Together?
Suppose you receive workers’ compensation payments or other public disability benefits together with SSDI disability payments. In that case, the total amount you receive can’t be more than 80 percent of your recent average earnings before you became disabled. If it is, your SSDI benefit will be reduced so that your total benefits aren’t over 80 percent.
Say you make an average of $3,000 per month at your job and received SSDI payments of $1,200 before your injury. After your injury, you started receiving workers’ comp payments of $2,000 per month. Together, your benefits equal $3,200 per month. But because your total benefits can’t be more than 80 percent (or $2,400) of your average $3,000 salary, your SSDI is now reduced by $800 [$3,200-$2,400=$800]. Your new SSDI payment is $400, and you’re liable for paying taxes on the $800 monthly reduction. In this example, the IRS would essentially say $800 of your worker's comp is actually SSDI, which is taxable.
Your SSDI may also have a workers’ compensation offset if you receive a lump-sum workers’ compensation settlement. The Social Security Administration (SSA) asks you to contact them right away if you receive one.
If your workers’ comp case is complex, you may benefit from working with a workers’ compensation attorney to ensure your settlement is structured in a way that can minimize your tax liabilities for the most recent tax filing year.
Do You Have to Report Workers’ Compensation on Your Tax Return?
Your workers’ comp benefits aren’t usually taxable, so you don’t have to report workers’ compensation benefits on your income tax return or pay state or federal taxes on them. That’s because your payments are 100 percent tax-exempt. You shouldn’t see your workers’ comp income on your W-2, and you don’t have to add it to your return. The exception is if you’re also receiving SSDI and have your payments reduced. In that case, you’ll pay taxes on the reduced amount.