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Is Workers' Comp Taxable?

Published December 22, 2023 by Matt Fendon Law Group | Workers' Compensation
Is Workers’ Comp Taxable?

If you have been injured at the workplace, then you might be able to receive workers’ compensation benefits. These can help you to offset lost wages when you cannot work, but you might be asking yourself, “Do I need to set aside part of my workers’ comp benefits for taxes?”

Fortunately, the short answer to this question is that generally your workers’ compensation benefits are not taxable at the federal or Arizona state levels. There are some limited exceptions to this general rule that we will cover below, but unless they apply to you then you need not worry about paying taxes on your workers’ compensation benefits.

If you have questions about your workers’ compensation benefits, including how to claim them, how much you might receive, and how long they will last, one of our Arizona workers’ compensation attorneys at Stone Law can help you with answers to these questions and more. Call us at (800) 229-3880 to speak with a workers’ compensation lawyer. 

When is workers' compensation taxable?

What Does Workers’ Compensation Pay For?

The purpose of workers’ compensation is to help you to keep going if you cannot work because of an injury, illness, or medical condition that happens to you in connection with your employment. Through workers’ compensation you can receive the following kinds of assistance:

  • Payment for reasonably necessary medical treatment expenses.
  • Partial replacement for lost wages.
  • Ongoing care benefits, such as physical therapy.
  • Funeral cost reimbursement for employees who die because of work-related causes.

When is Workers’ Comp Taxable?

By themselves your workers’ compensation benefits are not subject to federal or state income taxes. But if you combine workers’ compensation with other government-provided benefits, then you can be subject to taxation on some of the benefits you receive.

The two kinds of other government benefits that can affect the tax status of your workers’ compensation benefits are both connected with the Social Security Administration::

  • Social Security Disability Insurance (SSDI). 
  • Supplemental Security Income (SSI).

What is SSDI?

SSDI is a tax-funded federal insurance program that pays Social Security benefits to people who meet the following eligibility criteria:

  • You must have a disability.
  • You must be on a limited income.
  • You must have paid into Social Security through payroll taxes for a minimum period, usually between 5 and 10 years.

SSDI benefits are taxable.

What is SSI?

SSI is a supplemental income program that provides monthly cash benefits and healthcare coverage to people who qualify. A main difference between SSI and SSDI is that SSI has no work credit requirement for eligibility like SSDI does.

SSI eligibility criteria are:

  • You must be a US citizen.
  • You must reside in one of the 50 states or the District of Columbia.
  • You must be older than 65 years of age.
  • You must be blind or otherwise disabled.
  • You must be on a limited income.

SSI payments by themselves are not taxable. If you receive workers’ compensation and SSI at the same time, however, then the amount you receive in workers’ compensation is considered income and is deducted from the Federal Benefit Rate (FBR) you receive. The FBR is $733 for an individual or $1,100 for an eligible couple. 

Federal Taxable Benefit Income Combinations

Workers’ compensation payments to you can become taxable at the federal level when you combine them with Social Security benefits. Specifically, if your combined workers compensation and SSDI benefits add up to more than 80 percent of your average earnings, then if your SSDI amounts are taxable then the SSA will reduce your SSDI payments through workers’ compensation offsetting. 

Your SSDI Benefits Must Be Taxable

Workers’ compensation offsetting for federal taxes only happens if your combined benefits are enough to be taxable. 

Although SSDI payments are not generally taxable by themselves, if you make additional income on top of your Social Security benefits then you could be subject to tax on those benefits if your combined income is more than a set amount.

Your “combined income” is based on the following formula:

  1. Start with your adjusted gross income for the tax year.
  2. Add to this amount any nontaxable interest income you receive.
  3. Add to this combined amount one-half of your annual Social Security benefits.

The sum of 1 through 3 above is your combined income.

For example, if you file your taxes as an individual, and your annual combined income is between $25,000 and $34,000, then you could be subject to income tax on up to half of your Social Security benefits. If your combined income is more than $34,000 annually, then your Social Security benefits could be subject to taxation at an 85 percent rate.

If you file your federal income taxes jointly, then the 50 percent tax rate on Social Security benefits kicks in between $32,000 and $44,000 yearly, with the 85 percent tax rate applying to annual combined income more than $44,000.

For example, let’s say that your average earnings were $4,000 monthly. After your work-related injury you collect both workers’ compensation and SSDI, in the following amounts: $2,000 monthly in workers’ compensation benefits, and $1,400 from SSDI, for a total of $3,400. This amount, however, is more than 80 percent of your average earnings, which would be $3,200.

In this case, the Social Security Administration will reduce your SSDI benefits by $200 to bring your combined disability compensation down to $3,200 to match the 80 percent threshold. But you will still be subject to federal tax on the $200 offset amount because under IRS rules it is considered to be workers’ compensation instead of SSDI.

Workers’ Compensation and State Taxes

You have two main considerations to keep in mind when it comes to how states tax workers’ compensation. 

First, those states that may tax workers’ compensation consider it to be income. Not all states have an income tax. So, if you live in such a state, your workers’ compensation is not taxable at the state level.

Those states that do tax workers’ compensation benefits usually apply the same rule for federal taxation: workers’ compensation is generally not taxable, but if your combination of workers’ compensation and SSDI is more than 80 percent of your pre-injury wages then you can be subject to tax on the offset portion above 80 percent.

This is not a universal rule. Each state has its own rules for whether to tax workers’ compensation. 

  • As we have noted above, some states with no income tax will not tax workers’ comp benefits under any circumstance.
  • There are some states that, in cases of permanent total disability, reverse the federal rule: instead of reducing your SSDI, these states allow you to keep your full SSDI amounts and reduce your workers’ compensation benefits instead.
  • If you have received non-workers comp payments for your injury, or if you have deducted related medical expenses for it, this can affect the taxability of your workers’ compensation.
  • If you are able to go back to work, including light duty, then your work income will be taxable even if your workers’ compensation benefits are not. This is also true if you are collecting retirement benefits on top of workers’ compensation benefits.

Have you received a full and final settlement of your Arizona workers’ compensation claims? If so, then see our workers’ comp settlement taxation page for more information.

Talk to an Arizona Workers’ Compensation Lawyer Today

At the Matt Fendon Law Group, our highly skilled and compassionate workers’ compensation lawyers are ready to help you with all aspects of your workers’ compensation claim, including how to understand whether any of your compensation is taxable.

In addition, we can help you to: 

  • Understand what is happening with your claim. The process of obtaining workers’ compensation benefits can be stressful and complicated. It’s critical that you have an experienced Arizona workers’ comp lawyer on your side.
  • Deal with your employer and its workers’ comp insurer. Employers often try to intimidate or take advantage of injured workers. The attorneys at Matt Fendon Law Group will stand up for your rights.
  • Receive the compensation you deserve. While you recover from your work injury, workers’ compensation benefits pay a portion of your lost wages, as well as your medical bills. Our attorneys will fight to get you the benefits you need and deserve.
  • Represent you at hearings. A hearing before an administrative law judge could be required. When that is the case, our attorneys will represent you and argue on your behalf.
  • Handle your appeal. If your workers’ compensation claim is denied, our experienced workers’ compensation lawyers can help you to put together the strongest argument on your behalf within the tight 90-day appeal deadline.
  • File a civil lawsuit if necessary. If your employer fails to maintain workers’ compensation, litigation may be necessary. We can file a lawsuit on your behalf.

Call us today at (800) 229-3880 to schedule a confidential, free consultation with an experienced workers’ compensation lawyer in Phoenix. Or, if you prefer, you can contact us online to ask a question or to schedule a free consultation.

In addition to our Phoenix location, we have offices in Prescott, Flagstaff, Scottsdale, and Tucson. Let us show you how we can help you with your Arizona workers’ comp case. We will provide straightforward advice and help you understand your legal options.

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