The short answer to the question of whether your workers’ compensation benefits are taxable is “no”. Perhaps a better answer, however, would be “Usually not, but it depends on the circumstances”. You might suffer limited taxation liability if you receive workers’ comp payments in conjunction with SSDI or SSI; if you receive a lump sum workers’ comp settlement; or if you are awarded interest on a late workers’ comp payment.

Receiving Workers’ Comp Together With SSDI or SSI

If you receive workers’ comp together with SSDI or SSI, your total benefits may not exceed 80 percent of your “average current earnings”, which is calculated as either:

• Your average monthly wage as used to calculate your workers’ comp benefits;
• One-sixtieth of the total wages you earned during the highest-earning five years in a row during your working lifetime; or
• One-twelfth of your highest annual wages during the past five years.

If your total exceeds this 80 percent threshold, your SSDI or SSI payments with be reduced to the amount necessary to bring your total benefit down to this threshold. Whatever the amount of the SSDI reduction, that same amount of your workers’ comp benefits will become taxable just as
SSDI benefits are.

Example

For example, suppose Sue’s average current earnings are $1800 per month. Suppose further that she receives $1400 per month in workers’ comp benefits and $700 per month in SSDI benefits, for a total of $2100 in total benefits.

Since her average current earnings are only $1800, 80 percent of which represents the threshold, her threshold is $1440. Since she receives a total of $2100 per month, her monthly SSDI benefits will be decreased by $620 to bring her down to the $1440 threshold. That means $620 of her workers’ comp benefits will be taxable.

Lump Sum Settlements

In some cases it is possible to receive a lump sum settlement for an entire working lifetime of disability. If this amount is attributed to a single year’s income, it could cause serious tax problems. Your lawyer should draft the settlement agreement to specify that the amount is to be spread out over your entire working lifetime, so that not too much income will be attributed to you in any given year, including the year that you actually receive the settlement.

Interest

If you receive a delayed workers’ comp payment to which interest is added, you will have to pay income tax on the interest (but not necessarily the principal).

Don’t “Donate” Money to the IRS by Committing an Avoidable Tax Error

The IRS will do just fine without you donating money by paying more taxes than you actually owe. Contact Kentucky workers’ compensation lawyer Glenn Martin Hammond for a consultation, by calling (606) 437-7777 or by filling out our online contact form. We serve clients throughout Kentucky.