The good news is that worker’s comp is not normally taxable income at either the federal or state level. If you’ve received the IRS Form W-2 for these benefits, you can usually enter it as a negative amount under miscellaneous income on your 1040 form when filing your taxes.
When It’s Taxable
If you returned to work in the same year but were placed on light or restricted duty while still receiving medical benefits, you must consider any benefits received as taxable income. Even if workplace illnesses or accidents forced you to retire, you must still consider any workman’s compensation received on top of regular wages as taxable income.
If you received any pension based on work-related disability, some parts may be paid out from worker’s compensation. That portion should be identified per your pension plan and is not considered taxable income. Any remaining pension funds that are accrued from other sources based on years of service is still taxable. This is considered annuity income. Even if you pass away and leave your pension to your heirs, the worker’s comp portion is still not subject to tax.
In some states, your social security disability benefits are reduced, or offset, to adjust for workman’s compensation payouts. However, this is only done if the combination of both is greater than 80 percent of your prior working income. In the event that your social security is reduced, you still have to pay income on the amount of the reduction. For instance, if your social security is offset by $100 a month, you’re still taxed on that $100. The IRS provides a publication explaining all this.
Worker’s Comp Offset
In some states, it is the worker’s compensation benefits that are offset based on social security payments, and not the other way around. In that case, the workman’s comp benefits are not taxed at all, and only the remaining social security is taxed. But again, this only applies if the total exceeds 80 percent of your income when you were employed.
You must claim worker’s compensation as income if you’re claiming a deduction for the medical costs elsewhere. Any monies earned while on workman’s compensation are also subject to income tax. This includes interest, especially in those cases where worker’s comp amounts include earned interest.
If you’re receiving worker’s compensation, it’s always a good idea to consult an attorney who specializes in the field, or an accident attorney if the injury was car-related. They can help you to structure benefits to your best advantage and advise you on preparing your taxes.
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