If you’re eligible for temporary disability payments or permanent disability benefits through workers’ compensation, those benefits are generally tax-free. However, a portion of your workers’ comp benefits might be taxed if you’re also receiving Social Security Disability Insurance (SSDI) benefits, and part of those benefits have been offset by your workers’ comp benefits. Here’s how the offset and the taxation works.
In many states, if you’re receiving benefits through both Social Security Disability Insurance (SSDI) and workers’ compensation, and those combined benefits are more than 80% of your average earnings before you became disabled, the SSDI benefits will be reduced (or “offset”). The offset doesn’t apply to Social Security retirement benefits.
Taxes may be an issue when there’s an offset, because a portion of any Social Security benefits are taxed when your total income reaches a certain level. So if your SSDI benefits are reduced because of the offset with workers’ comp benefits, the amount of the offset could be subject to taxes (even though you received that amount as workers’ compensation benefits rather than as SSDI benefits) if your earnings for that year are high enough. The logic behind this rule is that the offset amount could have been taxable if you had received it from Social Security rather than through workers’ comp.
For example, say you would have been entitled to $1,200 in SSDI benefits and $1,000 in disability benefits through workers’ comp, for a total of $2,200 per month. If your pre-injury earnings were $2,500 per month, the combined benefits would be more than 80% of that amount ($2,200/$2,500 = 88%). That means that your SSDI would be reduced by $200 (to bring the combined benefits down to 80% of $2,500, or $2,000). In that case, $200 of your monthly workers’ comp benefits could be subject to tax if your total income is high enough. (See our article about taxes on Social Security benefits for details on income thresholds and what portion of those benefits may be taxed.)
In some states, the SSDI/workers’ comp offset reduces the benefits you receive from workers’ comp rather than your SSDI benefits. In that case, you aren’t taxed on any of your workers’ comp payments. (However, as discussed above, you will be taxed on a portion of your Social Security benefits if your combined income is high enough.)
The bottom line: Most people won't have to pay taxes on workers' comp benefits. Even if they do, the tax should only be on a small portion of those benefits. But it would be smart to speak with a lawyer if you’re concerned about the offset because you’re eligible for both SSDI and disability benefits through workers’ comp. An attorney experienced in workers’ compensation or disability could save you money by helping you minimize how much workers' comp lowers Social Security benefits.