Are Workers' Compensation Settlements Taxable?

Workers' comp settlements are crucial to injured workers being able to heal from their injuries and overcome time lost from being off the job. In most cases, the settlement amount for workers' comp cases is modest, averaging around $20,000. The majority of injured workers in settlements, about 55%, will receive anywhere from $2000 to $20,000. One of the largest settlements to date was from a California case decided in 2017 where $10 million was awarded to the injured worker for severe, long-lasting ailments. With thousands and in rare cases millions of dollars going to injured workers' settlements, one question that looms for many recipients might be, "Will my workers' compensation settlement be taxable?"

In short, no. According to the Internal Revenue Service (IRS), workers' comp settlements under federal law do not qualify as taxable income for state or federal levels. Compensation from workers' comp earned from occupational injuries or illnesses is fully tax-exempt, provided the insurance carrier adheres to state workers' compensation laws. Injured workers can receive checks from their settlements without having to list the amount as earned income or paying taxes on the total amount at the conclusion of the year. Cases of settlement payouts being received by next of kin after a fatal incident to a worker are also considered tax-exempt. 

However, there can be other forms of payment that are taxable stemming from workplace injuries. When injured on the job, an injured worker can file and collect from workers’ comp and Social Security Disability Insurance (SSDI) at the same time. While workers' compensation settlements are not taxable, SSDI benefits are. Together, these programs cannot exceed 80% of your current average earnings. If this occurs, SSDI benefits may be reduced in a procedure called 'offsetting.'  If an injured worker’s SSDI benefits are reduced due to the offset with workers' comp benefits, the offset amount could be subject to taxes if earnings from that year are high enough. However, most people do not encounter this issue. If the offset does occur, over 15 states currently have reverse offset programs. By having reverse offset programs in place, a person's workers’ comp benefits will be reduced rather than the SSDI to ensure any offset will be taxed at the lowest possible amount.

Since workers’ compensation wages are largely considered non-taxable, this can help the injured worker keep more money from their settlement and pay lower taxes overall. No taxes on workers' comp benefits can possibly result in some individuals or families seeing their tax burden drop as they may qualify for a lower tax bracket.  

Keeping workers' comp settlements non-taxable remained consistent through decades of ever-changing policy and differing political landscapes. While there is a consensus that the current tax code ensures workers’ comp settlements are non-taxable, it is crucial to always keep in mind each state's workers' compensation systems' rules, regulations, and procedures.