Are Workman's Comp Disability Benefits Taxable?

by William Pirraglia

    Most workman's compensation disability benefits are not taxable. There is, however, an important exception to this basic rule. According to the IRS, the tax exempt rule does not apply if you receive retirement plan benefits tied to your age, length of service or any prior contributions you made. Even if you had to retire because of a workplace sickness or injury, you lose the tax exemption on workers' comp income.

    Workers' Compensation Benefit Tax Issues

    Step 1

    Clarify the type of workers' compensation benefits you're to receive. In most cases, these benefits are exempt from taxation at the federal and state level. The IRS states that, for an occupational sickness or injury, your benefits "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." However, when you receive both Social Security Disability and workman's compensation benefits, your Social Security benefit amount may be reduced. Since Social Security benefits can be at least partially taxable, depending on your other earnings, the IRS may tax you on part or all of your Social Security payments.

    Step 2

    Consult with a tax professional if you fall into the category of receiving retirement benefits as part or all of your workers' compensation disability payments. You'll be challenged to properly calculate the portion of your benefits that the IRS considers taxable. If you have only minimal additional earnings, depending on your age, you may be subject to equally minimal taxation. However, if your bank or investment accounts yield substantial annual income, you may find that workman's compensation payments considered retirement benefits will increase your annual taxable income.

    Step 3

    Carefully evaluate returning to work before you're well. Should you qualify for workers' compensation temporary disability benefits and return to work before you've totally healed to perform light duty tasks, you'll be taxed on the compensation you receive. Since you are working and being compensated, even if at the same reduced pay you received from workers' compensation, you lose the tax exemption, as you are once again earning taxable wages.

    Tips

    • You needn't choose between weekly payments, lump sums or medical payments, as all regular workman's compensation benefits are not taxable.
    • Learn the legal difference between temporary and permanent disability to be sure you apply for and receive the proper designation for tax and future work reasons.
    • Become knowledgeable about Social Security Disability programs to learn if you qualify.

    Warnings

    • Although a federal program, workers' compensation benefits can be subject to differing state laws that can enhance or restrict payments.
    • Don't neglect to plan for potential taxation, if your workman's comp benefits are considered retirement income.

    Photo Credits

    • Jupiterimages/Creatas/Getty Images

    About the Author

    For 34 years Bill Pirraglia served as a senior executive in the banking industry. Since 2005, he has authored articles, blog entries, tips and advice columns, SEO web copy and two published books. He specializes in personal and business finance topics, along with legal articles for clients large and small.

    Zacks Investment Research

    is an A+ Rated BBB

    Accredited Business.