One of the major concerns most workers’ compensation beneficiaries have is whether their benefits are taxable. At The Workers Compensation Attorney Group, we help you understand your legal rights to getting compensated for a work-related injury. Our great track record is based on enabling clients like you across Orange County, CA, recover damages when they are injured. We hope that this guide answers questions you may have regarding taxation in workers’ compensation benefits.
An Overview of Workers’ Compensation
Labor Code 5401(a) states that an employer should mail or give you a claim form after learning about your injury within one day. The process of recovering workers’ compensation benefits for an injury starts once you receive the claim form. You may seek the benefits for a work-related illness or injury. They may include disability (permanent or temporary) benefits, medical care or job displacement benefits, among others.
Once a workers’ compensation administrative law judge approves an award for your injury, your claim will finally be resolved. However, payments for both temporary and permanent disability will be made with a doctor’s authorization and stop when the doctor discharges you. Compensatory damages are not taxable (whether income, state or federal tax) in California. You will not also pay retirement fund contributions, taxes or Social Security from the awards.
Understanding the California Tax Law
The California tax law was enacted to conform with the federal tax law (the Internal Revenue Code, IRC). While there are similarities between these two laws, various differences also exist. California’s Franchise Tax Board (FTB) handles queries related to changes in federal tax returns. You can notify FTB if the IRS adjusted your tax returns and you qualify for a refund or owe additional tax.
Taxes are usually deducted from your income and additional income. Income, in this context, may include wages (salaries or tips), taxable interest income, pensions, and annuities or taxable interest income. Social Security benefits, HSA (health savings account) payments and dividend income also qualify as income.
The IRS (Internal Revenue Service) imposes taxes on additional income including alimony, tax refunds (offsets or credits or capital gains/losses. Unemployment compensation, rents, royalties, estates, partnerships, and business income are also considered as additional income. As a requirement of being tax compliant, you (the taxpayer) are required to file your tax returns regularly. Tax returns give an overview of the income you earned and the type and amount of taxes you paid.
California’s Tax Rates
Income tax rates in California vary each year since they are levied on income earned by both residents and non-residents utilizing California’s resources. As of 2018, there are ten tax brackets in the state with individuals in the highest bracket paying 13.3 percent of their annual incomes as taxes. Workers’ compensation benefits for physical injury or illness are not subject to any of these tax rates.
What is the IRS Policy on Workers’ Compensation Benefits?
The IRS (Internal Revenue Service) gave an exception for amounts received as workers’ compensation for a work-related sickness or injury. Since the amounts are usually paid under the workers’ compensation laws, the exception can apply to your dependents or survivors. Your retirement plan benefits would not be included in this exception even if an occupational injury or sickness forced you to retire.
What Happens When You Return to Work?
Your salary will be taxed as wages once you return to your workplace after benefiting from workers’ compensation benefits. Your employer may expect you to resume work after recovering from an injury (if it was a temporary one). If you choose to carry out light duties at your workplace while receiving compensatory damages, taxes will still be deducted from your earnings.
Are Disability Pension Payments Exempted from Taxation?
Part of your disability pension may qualify as workers’ compensation if it is paid pursuant to the workers’ compensation laws. That fragment of your pension will be exempted from tax while the remaining amount will be subject to tax based on your service years. The IRS usually taxes disability pension as annuity income or pension.
Will You Incur Taxes on Other Injury and Sickness Benefits?
An occupational injury or sickness may call for compensation of other benefits. The benefits include railroad sick-pay, FECA (Federal Employees’ Compensation Act) payments, and black lung benefit payments. Railroad sick-pay benefits are taxable while the black lung benefit payments and FECA payments are exempted from taxation. You will not incur any taxes on the following types of compensation:
Benefits received under health or an accident insurance policy paid by you or your employer
Compensatory damages recovered for physical sickness or physical injuries (whether recovered in periodic payments or a lump sum)
The compensation received or loss of a function or part of your body (whether temporary or permanent)
Will Your Medical Care Reimbursement Be Taxed?
Reimbursements made to injury victims seeking medical care are usually excluded from taxation. If your employer gives you a loan or an advance reimbursement for future medical costs, the amount will count as income. This amount will be taxed whether you suffered an injury or fell sick at work. The advance payment will not count as workers’ compensation since you did not make an injury claim before receiving it.
Are Workers’ Compensation Benefits Taxable if They are the Primary Source of Income?
If you are a victim of an occupational illness or injury, you may receive workers’ compensation benefits for even half a year or more than a year. You may be worried about having these benefits taxed during this period. These damages are fully exempt from any form of taxation even if you recover them for several years.
The tax-exempt status will be invalid for Supplemental Security Income earned at the time you received workers’ compensation benefits. You will incur taxes for the additional income earned in this duration. Your tax returns will only indicate the Supplemental Security Income leaving behind any amounts you received as workers’ compensation.
Are Proceeds From the Settlement of an Injury Lawsuit Taxable?
An injury claim can be resolved through a settlement offer, which is usually a lump sum paid by the party at fault for your injury. In the agreement, your employer may agree to pay for your personal physical sickness or injuries, lost wages, and mental anguish or emotional distress. Find out below whether settlement awards from an injury lawsuit are taxable.
Personal Physical Sickness or Physical injuries
A settlement award for personal physical sickness or injuries is non-taxable. The IRS does not require you to include this award in your income. However, if you paid medical expenses more than one year before receiving the settlement, you should file the portion of the award meant to cover those medical expenses as income to the extent it offered you a tax benefit. You should file the tax benefit amount on Form 1040 as Other Income.
Mental Anguish or Emotional Distress
Settlement proceeds earned for mental anguish or emotional distress caused by a work-related sickness or injury qualify as workers' compensation. However, if these proceeds do not come from an injury claim you made, you have to report them in your income. You should indicate the whole amount as Other Income on Form 1040.
While you will be spending time out of your workplace due to an occupational illness or injury, you need to seek salary compensation for the lost time. Your employer may agree to pay you lost wages (front pay, back pay or severance pay), which qualify as taxable wages. They are also subject to Medicare, Social Security, and wage base tax rates in place when you were paid. Since the employment tax applies to lost wages, you should report your lost wages on Form 1040 under the "Wages, salaries, tips" section.
Most injury victims seek punitive damages to hold the parties at fault for their work-related injuries or illnesses accountable. The IRS considers punitive damages as taxable income that should be reported on Form 1040 under the "Other Income" section. Their taxability status remains the same whether they are earned in a settlement for an occupational illness or injury.
Is There an Exception to the No-Tax Policy on Workers’ Compensation Benefits in California?
Your workers’ compensation benefits do not qualify as taxable income. However, a portion of these awards may be subject to taxation in various circumstances. Most of these circumstances depend on the supplemental benefits you receive on top of the workers’ compensation ones. If you were awarded social security benefits on top of your workers’ compensation ones, you might have to pay taxes.
It is possible to receive both workers’ compensation and Social Security Disability Insurance (SSDI) benefits. Expect the SSDI benefits to be subject to an offset if both benefits account for over 80 percent of your earnings before you were disabled. The offset will not affect your Social Security retirement benefits.
When is the Offset on SSDI Benefits Taxed?
Taxation authorities make it mandatory for part of your SSDI benefits to be taxable once your total income is beyond a given number. The taxes will still apply to your SSDI awards even if your workers’ compensation awards are almost equal to the offset amount. The reasoning behind these charges is that the authorities could still tax the offset amount if you earned it from SSDI benefits in the absence of the workers’ compensation ones.
A California judge ruled in favor of John to receive $1,000 as temporary disability benefits (which are part of the workers’ compensation benefits) per month. John is set to receive these damages together with $2,400 in Social Security Disability Insurance (SSDI) benefits every month. The total benefits he will be earning on a monthly basis equal to $3,400. John used to earn $3,000 per month before sustaining a work-related injury.
John’s combined benefits are 88 percent of the income he earned before getting injured. The offset amount on his SSDI benefits would be $680 for the combined benefits to be equal to 80 percent of his income. $680 of the damages he receives every month may be taxable.
Can You File Workers’ Compensation Benefits on Your Tax Returns?
Tax return forms are usually filed with relevant taxing authorities to report people’s expenses, income, and other useful information. They can allow you (a taxpayer) to request refunds for overpaying taxes, schedule tax payments or calculate your tax liability. You have to file them annually as a business or an individual with reportable income (including interest, wages or profits).
In California and other parts of the country Forms 1120 (for corporations), 1040 (for individuals) and 1065 (for partnerships) are used to file tax returns. The forms begin with a section for your personal information. The other three sections of the form are dedicated to listing sources of income, tax deductions, and tax credits. Though you may consider workers’ compensation benefits as part of your earnings, you do not need to list them in the tax return form since they are nontaxable.
What Makes Workers’ Compensation Benefits Special From Taxable Income?
The IRS requires you to report any amount received for personal sickness or injury as income through a health or accident plan (which your employer pays). If the health or accident plan is paid by you and your employer, only the amounts received courtesy of your employer’s contributions qualifies as income. You are not required to report any medical care reimbursements as income once you had the plan established. Workers’ compensation benefits will do not qualify as taxable income since they are meant to help you recover losses sustained from an occupational illness or injury.
What if Your Employer Sends You a 1099-MISC Form for Your Workers’ Compensation Benefits?
A 1099-MISC form is used to report miscellaneous payments made to you for rendering various services. The IRS mandates the company or individual making the miscellaneous payments to file them on a 1099-MISC form, which is sent to both the IRS and the service provider. A 1099-MISC form covers payments including awards and prizes, royalties or rent. You may need this form to report earnings gathered from an independent contracting job.
Your employer is not mandated to issue you a 1099-MISC form for the workers’ compensation benefits you recovered since these benefits are nontaxable. If this is the case, consider contacting your local workers’ compensation office for further assistance. Your employer can also rectify this error by filing a correct 1099-MISC.
The Exception to Including Workers’ Compensation in a 1099-MISC Form
If you received Supplemental Security Income or Social Security disability insurance as part of your workers’ compensation benefits, you can have them reported under the 1099-MISC form. Supplemental Security Income and Social Security disability insurance are considered as taxable income. They should be listed under the “Wages & Income” section of a 1099-MISC form.
Will the Tax-Exempt Policy be the Same if You Relocate to Another State or Get a New Job
You may be allowed to change jobs while recovering workers’ compensation benefits if you were not on temporary leave due to a work-related illness or injury. The awards for your injury claim will still not be taxed even if you change jobs. However, you need to notify your employer before leaving the company. If your illness or injury worsens in the process, your rights for recovering workers’ compensation benefits will remain the same as before.
Since workers’ compensation laws differ from state to state, you have to be cautious about your benefits when thinking about relocating to another state. The new state may permit low compensation for your losses or may have a shorter timeline for injury victims to get compensated. One thing that will not be affected by the relocation is the tax-exempt policy on workers’ compensation benefits.
Will the IRS Take Your Workers’ Compensation Benefits for Owed Taxes?
If you owe the IRS back taxes, the agency may employ various measures to recover the debt whether you just won a workers' compensation suit. The IRS has extensive authority to access your income streams or property if you fail to pay taxes. The agency will not directly levy your workers' compensation benefits unless you have them deposited in a bank account seized by them.
The Internal Revenue Service has the authority to garnish or levy a significant portion of your earnings or seize your personal or real estate property. Before seizing or garnishing your assets, the agency will send you a notice indicating their intent to proceed with this process. If you fail to honor the notice as requested, the bank account holding your settlement proceeds may be seized or froze.
When Can You Expect the Advance Notice
The IRS usually considers the seizure of property as a last resort for people who owe back taxes. Expect the agency to send a notice demanding you for payment. If you ignore the notice, the IRS will send you a second notice (30 days after the first one) warning you about the seizure of your property and informing you about your legal rights. The agency will also send you a separate notification if they intend on recovering your state tax refund.
One way to get IRS off your settlement money is by agreeing on an installment plan with the agency. In this case, you will be making the payments as requested without the IRS taking your workers’ compensation benefits or freezing/seizing your bank accounts. However, you should expect the IRS to take your tax refunds to pay the debt faster each year.
Are Attorneys’ Fees for a Workers’ Compensation Suit Taxable?
The California State Bar established Rule 4-200 to govern the amount of fees charged for legal services. Under this law, a member of the bar should not agree, collect or charge an unconscionable or illegal fee. The legal fees for an injury claim are determined by the circumstances and facts surrounding your agreement with a personal injury lawyer. Factors determining your attorney’s fees include:
The fee amount based on the value of the performed services
The level of skill required to handle your case
Your legal team’s experience and reputation
The amount of money involved in solving your case and the outcomes obtained
Time and labor needed
Your informed consent to the fee
In California, you will incur 10 percent, 12 percent or 15 percent of your settlement proceeds as attorney fees. Expect a workers’ compensation judge to authorize this percentage based on the time and work involved, the final result and the benefits awarded. You can also negotiate the legal fees at your initial consultation before signing the fee and representation agreements.
Apart from the legal fees, a workers' compensation case will attract various out-of-pocket expenses. They include filing fees, costs of depositions and fees for duplicating medical records. Others include fees for paying independent medical examiners, your lawyer's travel expenses and postage costs.
Are Attorney Fees for a Workers’ Compensation Claim Tax Deductible?
Attorney fees paid for a claim involving a work-related injury or illness are not tax deductible. However, if the fees are intended for a business expense, they are subject to taxes. Plaintiffs are required to make tax deductions of legal fees if the fees help them collect or produce taxable income.
Seek Legal Advice on Workers’ Compensation Benefits Near Me
An injury claim based on an occupational injury or sickness is usually resolved by an award of workers’ compensation benefits. Your legal rights remain the same from the moment you had the injury claim filed to the moment you recovered the benefits. You deserve every dollar from the award since a work-related injury or illness temporarily or permanently affected your income.
The Workers Compensation Attorney Group ranks among the best law firms in Orange County, CA for our custom approach to workers’ compensation law. Our experience is earned from helping clients like you. Allow us to pursue an injury claim on your behalf and offer you legal advice on workers’ compensation benefits - call our Orange County Workers Compensation Attorney at 562-485-9694 to speak with one of our representatives about your situation today!