You’re hurt at work and wonder what now? You need the income from your workers comp benefits, but is a workers comp settlement taxable?
That could seriously hurt your finances if you don’t plan accordingly. In this guide, we’ll show you how your settlement affects your tax liabilities and how you can minimize the taxes owed so you have enough money to cover your expenses while you recover from your injury.
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Is Workers Comp Settlement Taxable?
Generally speaking, no workers comp settlements are not taxable at the federal or state level. If you’re injured at work and receive payments to cover your medical expenses, loss of wages, and pain/suffering, they aren’t taxable in most cases.
But, like any tax situation, there are exceptions to the rule you must know.
How Does it Affect Your Tax Return?
You do not have to report workers comp income on your tax returns. If you received workers comp for the entire year, you would have no income to report on your taxes, IF it’s the only income you receive.
Now, there are exceptions. Here’s what you must consider:
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Do you receive Social Security Disability Income?
If you also receive SSDI with your workers compensation, you’ll pay taxes on the SSDI like usual. But there’s more.
By law, you can only receive up to 80% of your pre-injury earnings between SSDI and workers comp benefits. If your SSDI and workmen’s comp add up to over 80% of your pre-injury income, the Social Security Administration will offset your SSDI (reduce it) by the exact amount you’re over the threshold.
But, here’s the catch.
The amount the SS Admin decreases your SSDI and your workers comp covers it, is taxable. If your SSDI is decreased by $300 a month and replaced with $300 in workers compensation income, $300 of your workmen’s comp is taxable.
Do you receive retirement income?
Similarly, if you receive retirement income including withdrawing from your 401K or IRA, that income is taxable if you cross the threshold of the minimum required income to file taxes, not including your workers comp income.
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Did you return to work?
Many people on workmen’s comp end up going back to work on ‘light duty.’ Since you’ll earn income working but still get some workers comp, you’ll owe taxes on the earned income that isn’t the workmen’s comp income if it exceeds the threshold for taxable income for the year.
Here’s an example to show you how to tell is a workers comp settlement taxable.
John was hurt at work and unable to work for 14 months. He was provided a settlement from his job, which totaled $2,500 a month. John also receives Social Security Disability Income of $1,000 a month. Before John was hurt, he earned $4,000 a month. With SSDI and workers comp, he’d earn $3,500, but that exceeds 80% of $4,000 ($3,200). John’s SSDI is reduced by $300 a month, which means John owes taxes on $300 a month of his workmen’s comp income.
How Do I Maximize My Workers Comp Settlement?
Dealing with a work injury can be stressful not only because you’re hurt, but dealing with your employer and the insurance company too. To maximize your settlement, do the following:
- Tell your employer about the injury immediately
- Get medical treatment or advice right away
- Know your disability rating (temporary total or partial or permanent total or partial)
- Make sure the insurance company considers all wages you earned pre-injury
- Cooperate with the insurance company’s medical requirements
- Work with an attorney before talking to your insurance company so they don’t twist anything you say
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How Do I Reduce Taxable Income with Workers Compensation
Working with a qualified tax professional will help you maximize your workers comp settlement. At face value, it seems like you’d owe taxes on the difference if your income exceeds 80% of your pre-injury income, but there are ways around it.
If you receive a lump sum settlement, you can ask for it to be prorated over your lifetime. You still receive the settlement in one payment, but for tax purposes, it’s amortized over your expected lifetime.
Let’s say you’re expected to live another 360 months and you receive a settlement of $20,000.
If you spread it out over your lifetime, you’d make $41.67 a month. If this keeps your income under the 80% threshold including your SSDI, you avoid taxation on any portion of your workers comp and get your full disability income.
4 Easy Tips for Workers Comp
- Most people with SSDI and workmen’s compensation income still fly under the radar of making less than the requirement to file taxes
- The Social Security Administration deducts necessary expenses from your workers comp income which can eliminate any SSDI offset. The expenses include lawyer fees, medical expenses, and even dependent costs.
- Check if your state allows you to prorate your workmen’s compensation lump sum payment over your life expectancy or only through your retirement date (some limit you to your retirement date).
- Your workmen’s compensation income can lower your tax bracket if you’re married filing jointly since you don’t owe taxes on the income earned from your injury.
Remember: Keep track of your expenses and income on a spreadsheet or bookkeeping program such as FreshBooks.
Getting hurt at work is traumatic in more ways than one. You not only have to figure out how to physically cope with the situation, but you also have your finances to consider. Without your regular income, you may wonder how you’ll pay your bills.
With workers comp covering your income, you should be okay, but you won’t earn the full amount you earned before your injury. Because of this, taxation is a big deal. If you have to hand over a big chunk of change to Uncle Sam, you may wonder how you’ll get by.
Using a qualified attorney and tax professional is the key to successfully navigating workers comp income. There are ways to avoid taxation or at least minimize your tax liabilities while you recover.
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Until the next money adventure, take care from The Handy Tax Guy Team!
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