Workers Comp Benefits Not Taxable In Most Cases
Are Workers Comp Payments Taxable In Most States? We receive many emails each month from employees and employers on this very subject.
The tax liability of Workers Comp payments seems to ramp up this time of year when the tax filing season begins in earnest. One of our clients had fielded a question from an injured worker on whether or not they would owe taxes on Workers Comp benefits.
With so many new tax laws on the books, I thought I would go to the horse’s mouth, so to speak, and look up the IRS rule on Workers Comp benefits. The previous rules basically had said there is no tax liability for Workers Compensation payments to an injured employee.
For public employees, Publication 963 covers the subject:
Amounts received by police officers, firefighters, and other employees or their survivors for personal injuries or sickness incurred in the course of employment are excludable from income and social security and Medicare taxes if they are paid under a workers’ compensation act or a statute in the nature of a workers’ compensation act.
This exclusion does not apply to retirement plan benefits based on age, length of service, or prior contributions to the plan, even if the individual retired because of an occupational sickness or injury.
Workers’ compensation benefits are fully excluded from gross income and are not subject to employment taxes, income tax withholding or reporting. Amounts received under a statute in the nature of a workers’ compensation act, however, may be subject to employment taxes and reporting.
For non-public employees, Publication 525 spells out the rule:
Amounts you receive as workers’ compensation for an occupational sickness or injury are fully exempt from tax if they are paid under a workers’ compensation act or a statute in the nature of a workers’ compensation act. The exemption also applies to your survivors. The exemption, however, does not apply to retirement plan benefits you receive based on your age, length of service, or prior contributions to the plan, even if you retired because of an occupational sickness or injury.
If part of your workers’ compensation reduces your social security or equivalent railroad retirement benefits received, that part is considered social security (or equivalent railroad retirement) benefits and may be taxable. For a discussion of the taxability of these benefits, see Other Income under Miscellaneous Income, later.
Return to work. If you return to work after qualifying for workers’ compensation, salary payments you receive for performing light duties are taxable as wages.
Disability pension. If your disability pension is paid under a statute that provides benefits only to employees with service-connected disabilities, part of it may be workers’ compensation. That part is exempt from tax. The rest of your pension, based on years of service, is taxable as pension or annuity income. If you die, the part of your survivors’ benefit that is a continuation of the workers’ compensation is exempt from tax.
The bottom line answer is they should not be included – except under certain circumstances.
Please note that this is for Federal Tax purposes. The states have changed the tax implications of receiving WC benefits over the years. Your state could possibly tax your benefits separately from the Federal tax system.
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