Is Workers’ Compensation Taxable?

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If you acquire an injury at work and receive compensation through a workers’ compensation claim, you may have wondered whether the IRS will tax those benefits. In this article, we will examine the issue of taxation related to workers’ compensation benefits, aiming to clarify any confusion and help you understand your financial obligations and responsibilities concerning the Internal Revenue Service (IRS). For more information about your case, please speak to your certified public accountant or workers’ compensation lawyer.

Workers’ Compensation: Definition and Purpose

Workers’ compensation insurance provides financial assistance to injured employees or those who become ill due to their job. This insurance covers medical expenses, lost earnings, and rehabilitation costs, as well as providing compensation for permanent injuries or disabilities. In some cases, when a worker dies on the job, their family may receive financial support.

The primary purpose of workers’ compensation programs is to protect employees from the financial burdens associated with workplace injuries or illnesses. By offering a safety net of support, these programs encourage employers to maintain safe and healthy working environments and help injured workers recover and return to work more quickly.

State law mandates workers’ compensation programs, and state agencies regulate these. While the specific rules and regulations governing workers’ compensation may vary from state to state, most programs share the same basic principles and goals. Employers must carry workers’ compensation insurance or self-insure, and employees may receive benefits if they suffer work-related injuries or illnesses.

Federal Tax Laws on Workers’ Compensation

The IRS generally does not tax workers’ compensation benefits. You may not need to report these benefits on your federal income tax return or pay taxes on them.

When the workers’ compensation claim involves a deceased worker, the IRS may not subject any benefits paid to the worker’s survivors to federal income tax. This includes death benefits provided to a spouse, children, or other dependents of the deceased worker.


The IRS may tax some workplace injury benefits, like Social Security Disability Insurance (SSDI) or Supplemental Security Income (SSI) benefits, if the combined benefits from workers’ compensation and SSDI or SSI exceed a certain threshold. More detailed information about this follows in our section about SSDI and SSI offsets.

State Workers’ Compensation Tax Laws

While federal tax laws generally exclude workers’ compensation from taxable income, state tax laws can vary in how they treat these benefits. Some states may entirely exempt workers’ compensation benefits from income tax. In contrast, others may tax a portion of the benefits under specific circumstances.

Given the variation in state tax laws, you must refer to the state’s specific regulations governing workers’ compensation. Your accountant or workers’ comp lawyer can explain your tax obligations and head off any legal and financial consequences.

SSDI and SSI Offsets

Federal SSDI and SSI programs provide financial support to individuals unable to work due to a disability. Social Security taxes fund SSDI and provide benefits based on an individual’s work history. SSI is a needs-based program to assist those with limited income and resources.

If you receive workers’ compensation and SSDI or SSI benefits, the federal government may tax some of your workers’ compensation benefits. This occurs when the combined total of your workers’ compensation and SSDI or SSI benefits exceeds 80 percent of your pre-disability income—also called the applicable limit. Social Security considers the excess amount an offset and treats it as taxable income, which may reduce your SSDI or SSI benefits.

Settlements and Lump-Sum Payments

The injured worker and the employer or insurer may settle some contested workers’ compensation cases. A settlement is a negotiated agreement that resolves the workers’ compensation claim, often in exchange for a lump-sum payment or structured payments over a specified period. These settlement payments generally include compensation for lost income, medical expenses, and pain and suffering.

The taxability of a workers’ compensation settlement can depend on the allocation of the settlement amount and the type of damages included. The IRS generally does not tax compensation for lost income and medical expenses. It might tax compensation for emotional suffering.

Tips for Navigating the Tax Implications of Workers’ Compensation

These tips can help avoid tax problems with your workers’ compensation benefits.

1. Call a tax professional or attorney

Hiring a tax professional or an attorney experienced in workers’ compensation law will ensure you understand the complex tax consequences of your benefits and make informed decisions about your claim and financial planning.

2. Keep records

Maintain accurate and complete records of your workers’ compensation benefits for tax purposes. Keep copies of all documents related to your claim, including benefit payment statements, settlement agreements, medical bills, and any correspondence with your employer, the workers’ compensation insurance provider, or the workers’ compensation administrator. You need these records for accurate tax reporting, if you face an audit, or need to defend your tax treatment of workers’ compensation benefits.

3. Communicate with workers’ compensation administrators and insurance providers

Stay in regular contact with the workers’ compensation administrator or insurance provider handling your claim so you understand your benefits’ breakdown and allocation. If you have questions or concerns about the taxability of your benefits or the distribution of a settlement, consult your attorney or tax professional to discuss your options and seek clarification.

Talk to an Attorney About Your Tax Requirements

Randal Klezmer, Attorney for Workers' Compensation in Indianapolis
Randal Klezmer, Indianapolis Workers’ Compensation Lawyer

The general rule is that workers’ compensation benefits are not taxable at the federal or state level. Exceptions exist, including situations involving SSDI, SSI offsets, and some other settlement payments. You must understand the tax implications of your specific workers’ compensation benefits is essential for financial planning.

Proper tax planning can minimize your tax liability and ensure you comply with all relevant tax laws and regulations. Each workers’ compensation claim has unique elements, so consult a tax professional or workers’ compensation attorney with experience in workers’ compensation law to address your specific situation.

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