Many people have asked whether their workers’ compensation benefits are taxable. The simple answer is that workers’ compensation benefits are not taxable. However, as with most legal issues, the answer is really not so simple.
There are two parts to workers’ compensation benefits. These include medical treatment and lost wage benefits (or indemnity benefits.) The value of the medical treatment you receive is never taxable. Period. You will never have to pay taxes on the value of any medical treatment you receive, for any money you receive for reimbursement of medical treatment, or, for any money you receive for the value of any future medical treatment. (Before I confuse anyone too much, the only way you can get money for future medical treatment is if you settle your workers’ compensation case. Otherwise, the Carrier pays for your medical treatment.)
Similarly, any lost wage benefits, you are paid are, in and of themselves, not taxable. This means, if you are receiving weekly benefits such as temporary total, temporary partial, permanent partial or permanent total disability, you cannot be taxed on this income. The complication arises if you are also receiving Social Security Disability benefits or are approved for Social Security Disability benefits while receiving workers’ compensation benefits.
Are Social Security Disability Benefits Taxable?
Social Security Disability benefits are taxable. So, when you receive a monthly check for Social Security Disability, you will be taxed on this income. The rules for calculating how much you will receive in Social Security Disability benefits include a limit on how much you can receive in disability benefits. This limit is 80% of the money you earned before your disability. In determining whether you make more than this amount, Social Security will calculate how much you earned prior to your disability.
This is a complicated calculation, but usually involves looking at the highest average year of earnings you had over the five years prior to the disability. (There are other methods of calculating the amount if you did not work the full five years or, if you were self-employed). Then, Social Security looks at the total you are receiving in disability, including workers’ compensation and other governmental disability sources and adds this to the amount of benefits you are entitled to receive in Social Security Disability. If the amount you receive in workers’ compensation benefits and the amount you are entitled to receive in Social Security Disability benefits is more than 80% of the total income you made before your disability, then they will “offset” the amount you are receiving in Social Security Disability benefits by the amount you are receiving in workers’ compensation benefits so the amount you receive will only total 80% of the total you earned before your disability. “Offset” is really just another word for subtract, with one distinction.
While the amount of the check you receive in Social Security Disability is reduced, the amount on which you are taxed is not. You will still be taxed on the full amount of your Social Security Disability benefits, even though you are not receiving the full amount. If you are receiving a weekly workers compensation check, the result will be that at least a portion, if not all, of your workers’ compensation benefit check that is not taxable as workers compensation, will be taxable as Social Security Disability Benefits.
Since examples are often easier to understand than an explanation, let me give you an example. If the average you earned before your disability $4,000 a month, then 80% of this would be $3,200. Let’s say you are eligible for $2,200 in Social Security Disability benefits and are receiving $2,000 per month in workers compensation ($400 per week) , the total of which would $4,200. So, Social Security will reduce the amount of the Social Security Disability benefits you will receive by $1,000 (or to $1,200 per month), to ensure that you do not receive more than 80% of the amount you were making prior to your disability. From a tax perspective, this means that you will only receive $1,200, but will be taxed on $2,200, so half of your workers compensation benefits, or $1,000 per month, just became taxable.
It is something to consider when deciding to apply for Social Security Disability benefits when you are also receiving workers compensation benefits. It is also one of the reasons we strongly suggest you consult a workers’ compensation attorney before doing so.
Full and Final Workers Comp Settlement
If your workers’ compensation benefits are paid as a full and final settlement, then the proceeds that you are paid for the settlement are not taxable, with two exceptions. First is, again, the Social Security issue described above. Fortunately, when workers’ compensation proceeds are paid in a lump sum, the amount that Social Security can offset is controllable. There is language that can be put in the settlement documents to protect the Social Security Disability benefits from this offset as much as possible.
An attorney who specializes in workers’ compensation will know this and can ensure that this language is included. What this does is to clarify how much of the settlement is to be allocated to non-offsettable amounts, such as medical treatment or attorney’s fees. Then, the remaining language is pro-rated over the course of your life expectancy (instead of maximum of 500 weeks allowed in workers compensation benefits.) This then reduces the amount Social Security Disability will look at as offsettable to the lowest amount possible.
Second, as part of a full and final settlement, either an insurance company or the pre-injury employer will want a release signed as part of the settlement. While each agreement will be different, in general, this will mean you agree to release the pre-injury Employer from any other claims you may have against them. An amount of the settlement will be given for your agreement to the release. This money is called the “consideration”.
Any money paid for a release of claims you may have against another party is taxable. This means that the portion of the settlement that is designated for your agreement to this document consideration you are paid to sign this document can be taxable. For this reason, most attorneys representing injured workers will request that the consideration designated for your agreement to this be as low as possible. This is not because your agreement not to sue our employment is not valuable. It is to maximize the amount of the settlement you put in your pocket.
For example, and assuming that you are in the 30% tax bracket), if you settle your workers’ compensation case for $10,000 (after attorneys’ fees are paid) and $5,000 is give as consideration for giving up your right to sue the pre-injury employer, then $5,000 of that will be taxable and you may only get to keep $8,500. However, if you settle for $10,000 (after attorneys’ fees are paid) and you only allocate $100 for giving up the right to sue your employer, then only $100 will be taxable and you will get to keep $9,970.00.
So, while your workers’ compensation benefits are not taxable, there are other benefits you may receive that will change this. If you have any questions about your workers’ compensation benefits, you should always contact an attorney knowledgeable about workers’ compensation.
About the Author: Michele Lewane
The Injured Workers Law Firm is a Richmond, Virginia based firm solely focused on serving clients with workers' compensation claims in Virginia. If you have questions about your benefits or if you would like more information on the Virginia workers’ compensation system, order our book, “The Ultimate Guide to Workers’ Compensation in Virginia” , or call our office today (804) 755-7755.