A workplace injury comes with challenges that extend far beyond the physical pain. Lost wages, mounting medical bills, and uncertainty about the future can overwhelm injured workers. On top of that, many people worry about how workers’ compensation benefits will affect their taxes. After all, the last thing you want is for the IRS to take a portion of your much-needed benefits.
So, is workers’ compensation taxable?
The good news is that workers’ compensation benefits are generally not taxable. Still, there are important exceptions every injured worker should know.
Marker Law, LLC, a Naperville-based law firm with over two decades of experience, fights for clients to secure their workers’ comp benefits and understand how those benefits fit into their broader financial recovery.
This article explains whether workers’ compensation is taxable income, how workers’ comp affects your taxes, and what you need to know about reporting settlements or payments.
Contact us today at 331-295-8005 to discuss your case and learn how we can help you.
Key Takeaways
- Workers’ compensation benefits are generally not taxable, under both federal law and Illinois law, because they replace lost wages from a work-related injury.
- Most workers do not report workers’ comp benefits as income, including weekly wage-loss payments, permanent disability benefits, and medical coverage.
- Certain exceptions can affect your taxes, such as Social Security Disability offsets, taxable interest included in delayed settlements, or wages earned after returning to light-duty work.
- Receiving SSDI alongside workers’ comp can trigger a tax impact, as the offset portion of reduced SSDI benefits may be considered taxable income.
- Proper recordkeeping is essential, including settlement agreements, benefit statements, and medical documentation, in case the IRS requests clarification.
- Most workers will not receive a 1099 for workers’ comp benefits, unless a portion of their settlement includes taxable interest.
- Understanding how workers’ comp interacts with taxes can prevent costly mistakes, ensuring you pay only what is required under the law.
- Marker Law, LLC helps injured workers navigate workers’ comp and tax concerns, protecting their benefits and financial recovery after a workplace injury.
Is Workers’ Compensation Taxable Income?
Workers’ compensation benefits are usually tax-exempt at both federal and state levels. Exceptions apply if benefits are offset by SSDI, if you return to light-duty work, or if specific state tax rules apply.
For most workers in Illinois, the answer is no. Under federal and Illinois tax laws, workers’ compensation benefits are not considered taxable income. This compensation includes weekly wage-loss checks, payments for permanent disability, and medical coverage provided under the Illinois Workers’ Compensation Act.
The reasoning is simple: these benefits replace wages lost because of a workplace injury or illness. They are not “extra income,” but a safety net to help injured employees recover.
When Workers’ Compensation Might Affect Taxes
While workers’ comp benefits are usually tax-free, some situations may affect your taxes. Understanding these scenarios can prevent unwelcome surprises at tax time.
Offset of Social Security Disability Benefits
Sometimes workers receive workers’ compensation and Social Security Disability Insurance (SSDI). The government limits the combined total of workers’ comp and SSDI benefits to about 80% of your average earnings before the disability.
If your workers’ comp benefits push you over that limit, the difference will reduce your SSDI payments. This reduction is called an “offset.” While your workers’ comp check is not taxable, the offset portion is considered taxable.
For example, imagine you earned $3,500 a month before your injury. Federal law limits the total of your SSDI and workers’ comp to 80% of that amount, or $2,800. If your SSDI benefit is $1,900 a month and your workers’ comp pays $1,200, the combined total would be $3,100, which is $300 more than allowed. In this situation, your SSDI payment would be reduced by $300. That offset amount is treated as taxable income.
Interest on a Workers’ Comp Settlement
If your case takes a long time to resolve, the final settlement may include interest on the benefits you should have been paid earlier. Unlike the settlement itself, which is generally tax-free, this interest is taxable.
Return-to-Work Wages
If you are cleared for light duty or part-time work while receiving partial workers’ compensation benefits, your wages are taxable, just like regular income. The workers’ comp portion remains tax-free, but the paychecks you receive for your work must be reported.
How Does Workers’ Comp Affect My Taxes?
Workers’ compensation benefits are generally not taxed by the IRS or most states because they replace income, not generate it. Exceptions apply for Social Security offsets, light-duty wages, or mixed settlements. Check state rules and consult a professional for cases involving multiple benefits or damages. However, making sure you identify any exceptions and pay the proper taxes when required can protect you from IRS problems down the road.
To stay safe, it’s a good idea to:
- Keep copies of your settlement agreement and benefit statements,
- Save all medical bills and related documents, and
- Consult a tax professional if you also receive Social Security benefits or other taxable compensation.
Even if the money is not taxable, having a paper trail helps answer IRS questions and confirms the accuracy of your return.
FAQs About Tax Reporting for a Workers’ Comp Settlement
When you receive workers’ compensation, the benefits are not taxable. So, you do not need to include the benefits as income on your tax return. However, you do have to report the compensation if an exception applies.
Therefore, holding on to all records is essential if the IRS requests further information.
What Employee Compensation Is Taxable?
It’s important to distinguish between workers’ compensation and other forms of employee compensation. Regular wages, overtime, bonuses, and vacation pay are taxable. Unemployment benefits are also taxable. Workers’ comp benefits, by contrast, are generally tax-free.
How Do Workers’ Comp Tax Rules Apply in Different Scenarios?
The general rule is that workers’ compensation benefits are not taxable. However, the way these rules apply can vary depending on your situation:
- Lump-sum settlements. The settlement is not taxable, but any interest included in the payout is taxable.
- Weekly disability payments. These are considered wage-replacement benefits and are generally tax-free.
- Social security offsets. If your workers’ comp reduces your Social Security Disability benefits, the offset portion may be taxable as Social Security income.
Understanding how these scenarios work can help you avoid mistakes in tax reporting for workers’ comp settlements and help ensure you pay only what is required under the law.
Do I Get a 1099 from Workers’ Compensation?
You will not receive a 1099 for standard workers’ compensation benefits. However, you may receive one if taxable interest is included in your settlement. This form would only cover the taxable portion, not the benefits themselves.
Are workers’ compensation benefits considered taxable income by the IRS?
Workers’ compensation benefits are not taxable under federal law and are not reported on your federal tax return if paid for a work-related injury or illness.
Can workers’ compensation benefits become taxable if I also receive Social Security Disability benefits?
Workers’ compensation benefits can make a portion of SSDI benefits taxable if your combined income exceeds federal limits, even though workers’ comp itself is not taxed.
Contact Marker Law, LLC and Protect Your Workers’ Comp Benefits from Tax Surprises
Nearly every injured employee asks, Is workers’ compensation taxable? For most people, the answer is no—benefits are tax-free under federal and Illinois law. Still, exceptions exist, and understanding them is essential.
If your case involves Social Security offsets, interest on delayed benefits, or other unique circumstances, proper tax reporting of a workers’ comp settlement helps you stay compliant while protecting your financial recovery.
Marker Law, LLC understands how stressful it is to balance medical recovery, financial uncertainty, and confusing tax rules at the same time. Its experienced team has the knowledge to explain your options and the compassion to guide you through every step. Recognized by Super Lawyers for over a decade and nominated for Best of Naperville in 2024, Marker Law, LLC is committed to making sure its clients feel supported, understood, and confident in their path forward.
If you have questions about your workers’ compensation claim, contact Marker Law, LLC today for a confidential consultation.