In the vast majority of cases, workers’ compensation benefits are fully tax exempt, at the federal, state and local level. But this is not always the case where the workers’ comp beneficiary is also receiving Social Security Disability Insurance (SSDI) benefits.
Workers’ comp programs, which are run at the state level, provide benefits to people who suffer from work-related disabilities, stemming either from specific incidents or from conditions that develop over time, otherwise known as occupational injuries. The federal SSDI program compensates people with sufficient work histories who are deemed unemployable due to their disabilities, regardless of any connection between the person’s employment and the disability.
As is the case whenever a person with Social Security benefits receives supplemental income, a person’s SSDI benefit becomes taxable if the combined SSDI and workers’ comp income exceeds $25,000 (or $35,000 for joint filers).
To further complicate matters, if the person’s combined income exceeds this, then the workers’ comp award may also become taxable where the person is subject to the workers’ comp offset. This rule exists to prevent a person from receiving a combined amount from SSDI and workers’ comp in excess of 80 percent of the person’s prior earnings. In such cases, the Social Security Administration will reduce the person’s SSDI benefit until it meets the 80 percent threshold.
However, the Internal Revenue Service still treats the reduced portion of the SSDI amount, or offset amount, as potentially taxable. So, for example, if a person’s SSDI benefit is cut by $300 to reduce their combined income to the 80 percent threshold, that $300 amount may be subject to the income tax, even though it is being covered by the workers’ comp carrier.
Furthermore, depending on the state program, some people receiving workers’ comp benefits return to the workforce via so-called “light duty work.” The IRS treats income from light duty work as taxable income as well.
Likewise, any supplemental income provided by an employer to a workers’ comp beneficiary, on top of what the state’s workers’ comp law requires, may also be taxable.
For more information on taxes and workers’ comp’ benefits, contact your tax professional or special needs planner.