When you receive workers’ compensation benefits, you might wonder how these payments impact your taxes. It’s a valid question, as not all income is taxed the same way. In California, specific rules apply to workers’ comp benefits, and understanding them can help you avoid surprises come tax season.
Workers’ comp benefits and federal taxes
In most cases, workers’ comp benefits don’t require federal income taxes. These benefits include payments for medical expenses, wage replacement, and disability. The law doesn’t tax these payments because workers’ comp compensates for work-related injuries or illnesses, and taxing those payments could seem unfair since they replace lost income.
However, if you also receive Social Security Disability Insurance (SSDI) or Supplemental Security Income (SSI) benefits, the IRS might tax some of your workers’ comp benefits. This situation happens when your combined income exceeds certain limits. The IRS might consider the total income too high and taxable under the “offset” rule, which means that the IRS taxes a portion of your workers’ comp benefits.
Workers’ comp benefits and state taxes
California follows the same federal guidelines when it comes to workers’ comp benefits and taxation. Workers’ comp payments usually aren’t taxed by the state. However, you should keep track of your total income if you receive other sources of income in addition to workers’ comp to ensure proper reporting.
Impact of workers’ comp settlements on taxes
If a workers’ comp case ends in a settlement, the lump sum you receive typically isn’t taxable. This rule applies to payments for lost wages and future medical expenses. However, if a portion of the settlement compensates for interest or punitive damages, the IRS may tax that portion.
Reporting workers’ comp income
Even though workers’ comp benefits generally aren’t taxable, reporting them accurately remains important. If you need to file a tax return, list all your sources of income, including workers’ comp payments, to avoid discrepancies.
Understanding how workers’ comp benefits affect your taxes will help you avoid unnecessary issues with the IRS and ensure compliance with state tax laws.