In California, workers’ compensation benefits are generally not taxable. However, there is an exception. Your benefits may be taxed if you also receive benefits through Social Security Disability Insurance (SSDI) or Supplemental Security Income (SSI) and your earnings are too high. If these are offset by your workers’ comp benefits, then your workers’ compensation would be taxed as if it were SSDI or SSI.
Workers’ compensation benefits are generally not taxable
The general rule is that workers’ comp benefits are not taxable. The California workers’ compensation system is a public benefit system that is funded by taxpayers. If those benefits were taxed, then the system would claw back a portion of the very benefits that it paid out. This would be inefficient.
The types of benefits that are tax-exempt under state and federal law are:
- temporary disability benefits, which cover your wage loss while you recover,
- permanent disability benefits, which cover your future lost wages due to an impairment caused by your workplace injury,
- death benefits, which are paid to the dependents of the victim of a fatal workplace accident, and
- medical expenses related to the injury.[1]
There is an important exception to this general rule, though. Additionally, any benefits that you receive from outside the workers’ comp system are likely to be taxed.
The exception: SSI or SSDI offsets
Some injured workers receive workers’ compensation from the state of California as well as from federal public welfare funds like:
- Supplemental Security Income (SSI), and/or
- Social Security Disability Insurance (SSDI).
Under federal law, however, the total amount that you receive cannot be more than 80 percent of your average earnings from before your injury.[2] If all of your benefits total more than that amount, the federal benefits are offset or reduced. They would be reduced until you were only receiving 80 percent of your prior earnings.
Importantly, Social Security Disability benefits are taxable if your other income, plus half of your SSDI benefits, would be over:
- $25,000 if you are filing your taxes separately, or
- $32,000 if you are married and filing jointly.[3]
Therefore, if you are over these threshold amounts, and your SSDI benefits get offset down to 80 percent of your pre-injury income by your workers’ comp benefits, then the amount of workers’ compensation that replaced your SSDI income is taxed.
“The tax implications of the workers’ compensation offset can be significant, though the lawyers at our law firm have found that it is also quite rare. You generally only receive SSDI benefits if you do not have much income. Under California’s workers’ compensation law, the temporary disability payments from your workers’ compensation claim only cover two-thirds of your wage loss. These generally do not raise you above the federal levels of income that trigger SSDI tax liability. You should always discuss the tax situation with your lawyer before accepting a workers’ comp settlement, though.” – workers’ compensation attorney Neil Shouse
Non-workers’ comp benefits are taxable in California
Injured workers may earn money through sources other than the workers’ compensation insurance system. These are often:
- wages from light duty,
- retirement benefits,
- tax deductible medical costs, and
- payments from workers’ compensation discrimination.
The money from these sources is likely to be taxed.
Light duty wages
If you return to work on light duty, then the wages that you receive are taxed by both the state and federal government. These are considered wages, not workers’ compensation. It is subject to income tax.
Retirement benefits
Any retirement benefits that you receive are taxable. This is the case even if you only retired because of a work-related injury.
Tax-deductible medical bills
While workers’ compensation benefits include covering the costs of your medical care, you may pay some out of your own pocket. If you deduct these expenses from your taxable income on your tax return, but are then reimbursed by the workers’ comp program, that reimbursement will be taxed.
Workers’ compensation discrimination
California employers are forbidden from retaliating or discriminating against someone for filing for workers’ comp. If they do, you can file a lawsuit known as a “132a claim.” Among other things, this claim can recover an increase in your permanent disability benefits.[4]
Your workers’ compensation payments for your disability are typically non-taxable income. This increase to those benefits, however, is taxable. It is due to your employer’s discrimination, not your work injury. 132a claims are filed against your employer, not the insurance company. This is because your employer’s conduct falls outside the insurance agreement. While they increase your disability benefits, they are not from workers’ comp.
Legal Citations:
[1] See Internal Revenue Service (IRS) Publication 525.
[2] See Social Security Administration (SSA) Handbook, section 504.2 and 20 CFR 404.408.
[3] IRS Frequently Asked Questions About Regular and Disability Benefits.
[4] California Labor Code 132(a) LAB.
