IRS Workers Comp Rules – Pay Attention To These Three Closely
Every year near the personal tax filing deadline, we receive questions on IRS Workers Comp rules. This year was no different with the COVID-extended deadline of July 15th. I decided to cover the one IRS Workers Comp Rule that I cover every year plus two quirky yet costly tax situations to avoid if you are receiving workers comp benefits (medical or indemnity).

I was reading a great tax book, Jeffrey Schnepper’s How To Pay Zero Taxes over the last week. I noticed that his book covered two other IRS “no-nos” on filing taxes with workers comp benefit payments.
The first one is one that almost everyone knows – the other two are ones that should be followed closely. After all, who wants to run afoul of the IRS?
Are Workers Comp Benefits Taxable?
In almost all cases, WC benefits are non-tax items. You are receiving 2/3 of your average weekly wage. If Worker Comp benefits were taxable, then your “take-home-pay” would be less than 50% of what you were previously earning in your job.
Before signing any worker’s comp agreements from the insurance carrier, be very sure of the Average Weekly Wage that appears on the form. Check your W-2’s from last year and your current paycheck stubs.
If something looks amiss, email the claims adjuster to make sure your Average Weekly Wage figure is correct.
Supplemental Payments From Your Employer – An Indirect IRS Workers Comp Rule
When I was reading Schnepper’s tax book, I said, of course, the supplemental payments are not workers comp. If no one explains that to the injured employee, they could end up owing a large tax bill. This would not be the goal of helping an injured employee while out of work.
Some governmental agencies such as public schools and other types of employers decide to “cover the income gap” by paying supplemental benefits to bring the injured employee up to 100% of their pay.
I have disagreed with doing this for years as supplemental payments may remove the motivation to return to work. I have written a few articles on this subject and include these payments in many presentations.
If an employer decides to offer supplemental payments, withholding taxes should apply the same as if the employee was presently working.
If the employer decides to not withhold taxes, then the injured employee could have a large tax burden. The burden would defeat the purpose.
Medical and Health Savings Accounts – The Hidden IRS Workers Comp Rule

The rule comes from deep in the Schnepper tax book. If an injured employee has workers’ comp medical bills that have been or will be paid by the worker’s comp insurance carrier, these cannot be turned in to a Medical Savings Account or a Health Saving Account.
Doing so would be effectively “double-dipping” from two different benefit accounts. The IRS could disallow the Health Savings Account resulting in a huge tax bill
Who would have thought about that IRS workers comp rule?
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4 Responses
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Does this apply to Canada also or just US?
Hello to our Canadian blog and newsletter readers. Thanks for commenting on our Internal Revenue Service articles. The IRS articles are very popular every time one is produced. Check out this link on the IRS’s determination of whether a worker is an employee or a contractor.
Billy, we receive a large amount of traffic from Google and Bing searches along with many article and newsletter readers. The IRS article are always very popular. Try this one.