You generally don't have to pay taxes on your workers' compensation benefits unless you are also receiving other benefits that push your total income above a certain level. According to the IRS, workers' compensation benefits generally do not fall within the category of taxable income, and you generally don't have to report it in a tax return.
The Workers’ Compensation Offset
If you're receiving workers' compensation benefits and additional benefits from Supplemental Security Income or Social Security Disability Insurance at the same time, the total amount of those benefits received cannot be more than 80 percent of your average current earnings. If those combined benefits do exceed that amount, the Social Security Administration may lower the SSI or SSDI payments to keep the total amount of benefits at or below the 80 percent limit.
Average Current Earnings
- The average monthly wage on which your benefits calculation is based
- 1/60 of your total wages for the five consecutive years in which you earned the most income, or
- 1/12 of your total wages from the year in which you earned the most in the previous five-year span.
If you're eligible for the workers' compensation offset, the taxable amount of the benefit is equivalent to the amount by which the Social Security benefits are reduced.
Some states apply the offset to workers’ compensation benefits instead of Social Security benefits. In this case, you're not required to pay taxes on any of the worker’s comp benefits.
How the Offset Is Calculated
Before calculating how much your benefits will be reduced, the SSA deducts any prior or anticipated medical costs, legal expenses, payments to dependents and any fees associated with the workers' compensation benefits. However, you shouldn’t rely on the SSA to automatically perform this adjustment. You should supply appropriate documentation that supports the relevant claims.
Generally speaking, most people won't be taxed on workers' compensation payouts, and in the rare situation that they are taxed, the payment will likely be a very small percentage of their benefit amount.
Getting Professional Legal Advice
It’s a good idea to consult with a lawyer who specializes in workers’ compensation claims and has experience assisting people who receive Social Security checks as a source of income. A legal professional can help you gather the right documentation for the SSA to review, and can also identify ways to reduce taxable liability in relation to workers’ compensation settlements. For example, settlement payments can be restructured in such a way that taxes are minimized.