Are Worker's Compensation Settlements Taxable?
The workers' compensation system provides injured workers a mechanism that allows for swifter attention to some of the more immediate financial needs of an injured worker. The system also is designed to allow for a comprehensive settlement of the case providing the injured worker with different types of compensation. An issue associated with the system is which elements of a workers' compensation settlement are taxable.
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Disability
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In many workers' compensation cases, a settlement is reached that includes payment for a permanent or temporary disability. The award will most likely be for a partial disability, although in many cases a person with a 100 percent disability is not able to return to work. The portion of the settlement that provides compensation for damage done to a person's body is not taxable. The theory is that this portion of a workers' compensation settlement is designed to make a person whole, using money to do so.
Medical Expenses
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Another element of a typical workers' compensation settlement is payment for past and future medical expenses. The reality is that a person who has injuries from the workplace likely will deal with medical issues into the future. A workers' compensation settlement is designed, in part, to take these expenses (both past and future) into consideration. Compensation for medical expenses is not taxable because an injured worker is not gaining anything by being compensated for medical expenses. This is another situation in which the worker merely is being made whole in response to a sustained loss.
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Pain and Suffering
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Obviously, workplace injuries can be painful. Yet another element of a workers' compensation award involves pain and suffering. An injured worker is entitled to compensation for the pain she endures as the result of the injury. A payment for pain and suffering is another example of an element of a comprehensive workers' compensation award that is designed to attempt to make a person whole. Consequently, the injured worker faces no tax liability for this type of recovery.
Lost Wages
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A workers' compensation settlement includes a provision dealing with lost wages. If the injured worker is not able to return to her job because of injury or if the injured worker has and will continue to lose wages, the settlement will provide compensation for future loss. Payments made to an injured worker for lost wages are taxable. The rationale is that this component of a settlement is enriching the individual. The injured worker is receiving the pay he would otherwise receive if no injury occurred, which would have been taxed. Therefore, for the purposes of federal and state income taxes, compensation for past and future lost wages is taxable.
Expert Insight
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A tactic that legitimately can be employed in the negotiation of a workers' compensation settlement is to keep that portion of the agreement providing for lost wages as low as possible. Money is allocated to a larger degree to other elements of the overall settlement that are not subject to taxation. In this way, the overall tax liability of the injured worker is kept to a minimum.
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