Is Workers Comp Taxable? Know Your Benefits and Obligations

Workers’ compensation plays an essential role in the lives of many employees who suffer from injuries or illnesses directly related to their jobs. When someone gets hurt at work or develops a work-related illness, these benefits help provide financial stability during what can be a difficult time. Workers’ comp can cover lost wages, pay for medical bills, and even offer ongoing support if the individual is unable to return to their previous position. However, while the benefits themselves are relatively straightforward, the questions that arise come tax season can be much more complex.

One of the most common concerns is whether workers’ compensation benefits are subject to taxation. Since workers’ compensation isn’t like a regular paycheck, people often wonder if they need to report it on their tax return, whether it counts as taxable income, or if certain conditions make it taxable. These are valid and important questions, and the answers can impact not just what you owe in taxes, but also how you plan for the future.

What Is Workers’ Compensation?

Workers’ compensation is insurance that helps cover medical bills and lost wages for employees injured or made ill by their jobs. Employers usually must provide this coverage so workers can get medical treatment, partial income replacement, and, in some cases, disability or death benefits. Workers’ comp is typically no-fault, so employees are eligible regardless of who caused the accident. The process involves reporting the injury to the employer and filing a claim with the insurance company. Most claims are approved, though denials can be appealed. In essence, workers’ compensation is designed to ensure employees can recover without financial hardship.

Is Workers’ Compensation Taxable?

Generally, workers’ compensation benefits are not considered taxable income under both federal and state law. According to IRS guidelines, these benefits are tax-exempt regardless of whether they’re paid in periodic installments or as a lump sum settlement. This exemption applies specifically to payments made under a workers’ compensation act or a similar law for on-the-job injuries or illnesses.

However, while the majority of workers’ compensation payments remain untaxed, certain scenarios can affect this status. For instance, if you’re receiving other disability benefits, such as Social Security Disability Insurance (SSDI), you may encounter an offset that indirectly introduces a taxable portion. In those cases, the SSDI payment, not the workers’ comp itself, is typically reduced to stay within the allowable income limits. That reduced portion can be subject to taxation.

For most recipients, though, the rule is straightforward: workers’ compensation benefits are excluded from gross income and do not need to be reported on a federal income tax return. This means that recipients of workers’ compensation generally don’t have to worry about tax liability stemming from their benefits. This allows them to focus on recovery rather than tax burdens.

Exceptions and Special Circumstances

Workers’ compensation is typically tax-free, but certain situations can lead to taxable income. Here’s what you need to know:

SSDI Offset: The Most Common Exception

If you receive both workers’ comp and Social Security Disability Insurance (SSDI), your total benefits cannot exceed 80% of your pre-injury earnings. If they do, the SSA reduces your SSDI payment—and that reduced portion is taxable.

Example:

• You earned $4,000/month before your injury.
• You now receive $2,500 from workers’ comp and $1,200 from SSDI ($3,700 total).
• Since this exceeds the 80% limit ($3,200), the SSA reduces your SSDI by $500—and that $500 is taxable income.

SSI Impact: Can Workers’ Comp Reduce Your Benefits?

Supplemental Security Income (SSI) is needs-based, so workers’ comp counts as income and can reduce or even eliminate your SSI payments. While SSI itself isn’t taxed, losing it may mean relying on other taxable income sources.

Returning to Work: When Wages Are Taxed

Going back to work on light duty means your wages are taxable, even if you’re still receiving workers’ comp.

• If your new job pays less, you may qualify for partial workers’ comp—only the wages are taxable.
• If you earn too much, your workers’ comp benefits could be reduced or cut off entirely.

Workers’ Comp and Retirement: What Changes?

If you retire while receiving workers’ comp, your benefits remain tax-free, but:

• Social Security retirement benefits may be taxable depending on your total income.
• Pensions and 401(k) withdrawals are usually taxable, which can impact your overall tax liability.

Reporting Workers’ Comp on Taxes

Workers’ compensation is not taxable and does not need to be reported on your tax return. However, if you receive other benefits alongside workers’ comp, you may have taxable income that must be reported.

When You Don’t Need to Report Workers’ Comp

• If workers’ comp is your only income, you do not need to list it on your tax return.
• The IRS does not require you to include workers’ compensation benefits as part of your taxable earnings.

When You Might Need to Report Other Income

While workers’ comp itself isn’t taxable, you may still need to file taxes if you also receive:

• SSDI benefits with an offset – If part of your SSDI was reduced due to workers’ comp, the reduced portion is taxable.
• Wages from light-duty or part-time work – If you return to work while receiving workers’ comp, your paycheck is taxable.
• Retirement income – If you are drawing a pension or Social Security retirement benefits while on workers’ comp, some of it may be taxed.

Conclusion

Workers’ compensation benefits are designed to provide financial relief after a workplace injury. It covers medical expenses, wage loss benefits, and rehabilitation costs. In most cases, these benefits are not taxable, meaning you do not have to pay taxes on your workers’ comp payments. However, exceptions exist, such as when receiving workers’ compensation offset through SSDI or returning to work while still collecting benefits. Understanding these tax rules and concerns about is workers’ compensation benefits taxable ensures you maximize your compensation without unexpected liabilities.

Navigating workers’ compensation claims and tax implications can be overwhelming. At Tomack Law, PLLC, we specialize in workers’ compensation cases in New York, ensuring injured workers get the benefits they deserve. If you need expert legal guidance, contact us today for a free consultation at (914) 500-2060 or email dtomack@tomacklaw.com. Let us help you secure the compensation you’re entitled to while protecting your financial future.

FAQs

Is workers’ comp taxed in NJ?

No. In New Jersey, workers’ compensation benefits are not subject to state or federal taxes. You do not need to report them as income when filing your taxes. However, if you receive other taxable benefits, such as SSDI, retirement income, or wages from returning to work, those may be taxable.

Is workers’ compensation taxable income?

No, workers’ compensation benefits are not taxable at the federal or state level. You do not need to report them on your tax return.

Do I have to report workers’ comp on my tax return?

No. If workers’ comp is your only source of income, you do not need to file a tax return. However, if you also receive SSDI, SSI, wages, or retirement benefits, you may need to report those.