How does workers' compensation affect tax returns?

Taxability of Workers' Compensation

Workers' compensation benefits are payments made to an employee who suffers a job-related injury or illness. According to the Internal Revenue Service (IRS), these benefits are generally not taxable at the federal level. This includes the workers' compensation awarded under a workers' compensation act or statute due to work-related sickness or injury. These benefits are non-taxable provided they are paid under a workers' compensation act or a statute in the nature of a workers' compensation act.

Impact on Individual's Tax Return

- Non-Taxable Workers' Compensation:

 - Workers' compensation benefits do not usually need to be reported as income on the federal tax return.

 - Since these benefits are not taxable, they do not affect the calculation of gross income.

- Exception - Retirement Plan Benefits:

 - If the worker receives a pension based on age, years of service, or prior contributions to the plan, rather than as a result of the work-related injury, then that portion of the pension attributable to the workers' compensation may be taxable.

 - If part of the workers' compensation reduces the Social Security or Railroad Retirement benefits received, that part is considered taxable.

- Reporting Requirements:

 - If the individual received a Form W-2 with workers' compensation reported as income (which should not typically be the case), they may need to report this on their tax return. However, it's important to ensure that the workers' compensation is not mistakenly reported as taxable income.

Conclusion

Workers' compensation benefits are generally not taxable and do not need to be included in taxable income on an individual's tax return. However, if the individual also receives Social Security Disability Insurance (SSDI) or Supplemental Security Income (SSI), and part of the workers' compensation reduces these benefits, that part may be taxable. It's important to differentiate between workers' compensation and other types of benefits that may have different tax implications.

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Sources:

Publication 525 (2023), Taxable and Nontaxable Income 2024-08-03

Publication 4128 Tax Impact of Job Loss - Internal Revenue Service 2024-08-03

Tax Implications of Settlements and Judgments - Internal Revenue Service 2024-08-03

Coronavirus Tax Relief and Economic Impact Payments | Internal Revenue Services 2024-08-03

Work Opportunity Tax Credit | Internal Revenue Service 2024-08-03

Publication 17 (2023), Your Federal Income Tax - Internal Revenue Service 2024-07-29

Unemployment Compensation | Internal Revenue Service 2024-08-04

Independent contractor (self-employed) or employee? 2024-08-03

Foreign agricultural workers | Internal Revenue Service 2024-08-01