Can Workers’ Compensation Settlements be Taxable?
Here is a common question asked by recipients of workers’ compensation benefits in New Jersey: Is workers’ compensation taxable? The answer is probably no. While there is a minor nuance to the question, both state and federal tax laws generally exempt workers’ compensation benefits from income tax calculations. This is because of the unique nature of the workers’ compensation system and the fact that workers are being “made whole” by receiving workers comp rather than generating income that would be subject to state or federal taxation.
What is Workers’ Compensation?
The workers’ compensation system in New Jersey is designed to help provide reimbursement for the cost of medical treatment injured employees must receive after a workplace accident. Many employees across New Jersey rely on workers’ compensation payments every day for their support and wellbeing while they are recovering from serious, debilitating bodily injuries.
A Brief History of Workers’ Compensation
Workers’ compensation laws are a relatively new labor law trend. Before the workers’ rights movements of the 19th and 20th centuries, workers’ compensation did not exist. If an employee was injured on the job, his or her only hope of compensation was through the regular court system. Personal injury law used to be relevant to workplace accidents, but the probability of winning a jury verdict was always uncertain, and the number of jury awards varied widely from not compensatory enough to overly burdensome on employers.
The workers’ compensation system was designed to provide an easy resolution for workers who suffered significant injuries in the workplace and to provide a specifically-calculated recovery so that an injured employee can get the type of care and medical coverage needed. The general rule of workers’ compensation is to provide an employee no more than what is needed to make a full recovery; however, a skilled and experienced workers’ compensation lawyer can often help you recover the most benefits to which you are entitled under the law.
IRS Publication 907
Most ordinary people who are not tax lawyers are not in the habit of reading IRS publications. However, they tend to contain a wealth of useful information about the protocols and regulations associated with federal taxation. IRS Publication 907 describes the extent of tax coverage of social security disability payments and dependent care benefits.
The publication answers most disability-related questions and serves as a fairly helpful guide to disability-like payments that may be relevant to workplace injuries. It describes the tax consequences of workers’ compensation, dependent care benefits, disability pensions, and social security disability.
In short, both dependent care benefits and workers’ compensation payments are generally excludable as income subject to federal taxation. The exclusion status means that your workers’ compensation benefits are not part of the taxable income calculation. This is contrasted from deductions in that a deduction must be reported and is either claimed as an above the line deduction or a below the line deduction. Unlike deductions, workers’ compensation payments simply do not get calculated for federal income tax.
If Workers’ Compensation is Generally Not Taxable According to IRS Publication 907, What is Taxable?
While workers’ compensation benefits are generally not taxable, other types of disability-related recovery may still be taxable as income. First, your social security disability payments may be taxable. If you do not work at all during the tax year, then your social security disability payments are generally not taxable. However, most workplace injuries allow employees to hold some employment, even if that employment is considered to be “light” work. If you earn some non-social security income, your social security disability may be taxable as income if your total income plus half of your disability payments equal more than $25,000 in income (for a single filer; $32,000 for married filing jointly).
Similarly, disability pensions are not tax-free. Because a pension is essentially a portion of your earned income that was set aside for retirement or other purposes, removing money from your pension before retirement counts as taxable income. Otherwise, pensions could be used to evade taxes, as anyone could simply put money into a pension and then immediately withdraw it.
Because money taken out of pensions (even disability pensions) constitutes income, it must be reported on line 7 of your Form 1040 (do not forget that medical expenses paid out of pocket are also deductible on a 1040; however, those expenses are subject to the 10% income limit).
Finally, if you retire while on disability leave, any lump-sum payment you receive for accrued annual leave will probably be considered a salary payment. The payment is not a disability payment. You must include that payment in your income in the tax year you receive it.
Other Workplace Injury Exclusions Under IRS Publication 907
According to IRS Publication 907, these other sources of income that may be related to your workplace injury recovery are also excludable as income:
- Supplemental security income (SSI payments);
- Compensatory (but not punitive) damages from a non-workers’ comp related lawsuit judgment or settlement;
- Veterans Affairs Disability Benefits;
- Certain military and government disability pensions (see IRS Pub. 525); and
- Benefits from a public welfare fund.
Additionally, while it does not directly count as “excludable,” you may be able to deduct any work-related expenses you have resulting from your disability and inability to perform work without assistance. According to IRS Publication 907, you can take a business expense deduction (rather than a medical expenses deduction) if you purchase equipment of some type that helps you work with your disability. For example, if you purchase a standing desk for your office-related employment, then that may constitute a deductible business expense that you could claim on your 1040.
How You can Reduce a Potential Large Tax Bill Through Your Workers’ Comp Settlement
There are many benefits of having a skilled and experienced New Jersey workers’ comp attorney handling your case. One of the most notable benefits is that your lawyer can actually work to structure the settlement you receive under workers’ comp to minimize a potential offset with other disability benefits. For example, your workers’ comp settlement agreement could state that a lump sum amount should be divided and disbursed throughout your expected lifetime. Under this scenario, you can still collect the entire lump sum, but that lump sum will be considered to cover the remainder of your life, in accordance with established actuarial tables.
For example, let’s say you receive a $15,000 workers’ comp settlement and you have an expected lifespan of 500 months. If the settlement agreement provides that the lump sum is spread out over your lifetime, the Social Security Administration will likely determine that the monthly amount you are receiving, for offset purposes, is only $30.
Our Team is Here to Help
If you or a family member was seriously injured at work, it is critically important to seek the advice and legal assistance from an experienced workplace injury lawyer at The Law Offices of Craig A. Altman. Our skilled attorneys have a reputation for success, which is why they are recognized as a top-notch workers’ compensation law firm. Call today at (856) 327-8899 or fill out a quick contact form so a member of our legal team can follow up with you.