Workers' compensation protects both workers and their employers. In exchange for benefits they receive in case of an on-the-job injury, workers are barred from suing their employers for liability for any accident that caused the injury. Workers' comp can take the form of medical benefits or indemnity payments for time lost from work. If a claim is settled, the workers' comp carrier offers a lump-sum payment for the release of the claim. The tax treatment is pretty simple because the benefits are tax-exempt.
WC and Disability Benefits
If your workers' compensation plan was established under the state law governing these contracts, then the IRS considers any benefits it pays out as tax-exempt. You do not need to report the benefits to the tax agency or file a tax return if workers' comp was the only income you received during the year. If you also draw disability insurance payments based on your job injury, this money is taxable if the employer paid the premium and did not report it to the IRS as compensation to you in the year he paid that premium.
Benefits and Taxes
The workers' comp exemption applies to the full range of benefits available to the injured worker, including emergency transportation, hospitalization, doctor visits, prescriptions, physical therapy and vocational rehabilitation. However, if you return to work on a light-duty or part-time basis under doctor's orders, any wages you draw are considered taxable compensation. In addition, the IRS would consider any payments made directly by your employer for medical care to be part of your compensation, and subject to income tax.
Disabilities and Pensions
The IRS might also exempt benefits you receive from a disability pension. Any part of the pension paid under a workers' compensation law is considered tax-exempt. This would also include annuities paid as part of a workers' compensation settlement. Any kind of pension that pays based on the length of time you've been working -- such as an ordinary employer-paid pension -- would be taxable, while any portion attributed to your own contributions is tax-free.
Work Comp and Social Security
Under federal law, the Social Security disability program may limit your benefits if you also receive workers' compensation payments. Your combined workers' comp and Social Security benefits can't be more than 80 percent of your pre-injury wage. If it exceeds that percentage, Social Security will "offset" your benefit. The IRS still considers the portion of your Social Security payment that is replaced by workers' compensation to be a Social Security benefit, which may be taxable depending on the amount of your other income.
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