Workers' compensation -- also referred to as workman's comp -- is paid to an employee who becomes sick or injured on the job and is consequently unable to work. Employers are required under state laws to purchase workers' compensation insurance plans to cover their employees in such circumstances.
Workers' Compensation Benefits
Workers compensation will pay two-thirds of the employee's regular salary -- up to a defined limit -- since the employee is unable to work and earn that salary. This insurance also pays for medical expenses related to the injury. If the employee dies as a result of the work-related injury, benefits will be paid to the employee's spouse and dependents due to the loss of income for the family. There also may be benefits available for long-term injuries such as carpal tunnel syndrome or hearing loss.
Income Tax on Benefits
Although workers' compensation is paid at less than the employee's regular salary, benefits paid under the Workers' Compensation Act are not taxed. The Workers' Compensation Act requires employers to purchase insurance to protect their employees and, therefore, determines that employers are liable for their employees' health and safety on the job. Benefits received by the survivors after the death of a covered worker are also tax-exempt.
Returning to Work
If the employee is unable to return to his previous job, workers' compensation will pay for training for a job the employee can do. After returning to work, the employee may be required to do light-duty assignments rather than the previous job that caused the injury. Salary payments for light-duty jobs -- even if they are paid at a lower rate -- are taxable as regular wages.
Retiring Due to Work-Related Injury
If you receive a disability pension because you are unable to return to work, part of that pension may be tax-exempt. The portion of a disability pension related to workers' compensation is tax-exempt, while the remainder, which is considered similar to retirement income, is taxable. Similarly, if the workers' compensation payments you receive cause your retirement payments to be reduced, the portion of benefits causing the reduction in retirement benefits will be taxed as retirement benefits.
Dawn Aldridge has worked in accounting and business since 2004. Her diverse experience includes public, small business and government accounting, as well as logistics and inventory management. She holds an MBA from the University of Illinois at Springfield.