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How Does My Workers’ Compensation Settlement Affect My Tax Return?

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Workers’ compensation benefits exist to provide relief to workers who suffer injuries in the workplace. Workers’ compensation can potentially help pay for immediate medical expenses and offset the economic impact of missing wages, but workers’ compensation may not fully cover the cost of a workplace injury. Some injured workers may wonder whether workers’ compensation benefits will affect their tax returns, and it is vital to understand how government benefits at the state and federal levels work to determine your tax obligations.

Taxability of Workers’ Compensation Benefits

Workers’ compensation benefits do not qualify as taxable income at the state or federal level. Lump sum settlements from workers’ compensation cases do not count as taxable income either. Usually, workers’ compensation benefits will not affect your tax return. If you are currently on workers’ compensation benefits and do not see a W-2 for the tax year while you were on benefits, do not panic. You will not receive any tax documents about your workers’ compensation benefits and it is not necessary to include your workers’ compensation as income when you file your taxes.

Despite the fact that workers’ compensation benefits do not typically count as taxable income, you could still encounter some tax issues in other ways depending on the types of other benefits you receive. For example, if you received workers’ compensation benefits and Social Security Disability benefits at the same time, you may receive a tax notification on the income received through Social Security Disability.

Social Security and Workers’ Compensation

It is possible to receive both Social Security Disability benefits and workers’ compensation benefits simultaneously with one important caution; the Social Security Administration will likely reduce your disability benefits to prevent you from earning more than 80% of your previous wages in benefits through a process called offsetting. The Social Security Administration calculates an acceptable offset based on your average current earnings.

Unlike workers’ compensation benefits, Social Security Disability benefits do qualify as taxable income. You should expect to pay taxes on all Social Security Disability income received. A certified tax professional can help you answer specific questions about your tax obligations following a workers’ compensation settlement.

Tax Obligations

If you received workers’ compensation benefits for an entire tax year, you will not need to pay taxes on those benefits. However, if you returned to work for any amount of time, even on light duty, you must pay taxes accordingly. Additionally, if you subsidized your income during your benefits period by taking money from a 401k or retirement plan, you will likely face a tax obligation for that income.

Your workers’ compensation benefits may not count as taxable income, but these benefits may still influence your tax return in other ways. For example, if you are married and your spouse continues working while you receive benefits for an entire tax year and you do not subsidize your income with any taxable income, you effectively earned no taxable income for that tax year.

If you and your spouse file your tax return jointly this could effectively place you in a lower tax bracket and lower your overall tax obligation. Since you pay no taxes on your workers’ compensation benefits your overall taxable income will be lower, and therefore your tax return may be less than it was when both you and your spouse worked for the entire tax year.

A workers’ compensation attorney can be a fantastic resource for anyone with questions about workers’ compensation benefits and how they affect tax returns. You may also want to make an appointment with a certified tax professional to ensure you meet your tax obligation for any time you did not work and received workers’ compensation benefits.