Workers’ Compensation, Social Security Disability Benefits, and Taxation

Generally speaking, workers’ compensation benefits are not taxable.  26 U.S.C. § 104(a)(1).  This includes compensation benefits paid under the Longshore and Harbor Worker’s Compensation Act or Defense Base Act.  See, e.g., Willis v. Comm’r, T.C. Memo 1997-290.  In contrast, social security disability benefits “may be included in the taxpayer’s gross income pursuant to a statutory formula that takes into account a number of factors, including the amount of Social Security benefits received, the taxpayer’s other income, and the taxpayers filing status.”  Sherar v. Comm’r, T.C. Summary Opinion 2011-44; 26 U.S.C. § 86.

There is, however, a way for the United States government to tax workers compensation benefits.  When the claimant is receiving both workers compensation benefits and social security disability benefits, the social security benefits are reduced because of the receipt of workers compensation benefits.  This is known as an offset.  For tax purposes, this offset amount is treated as though it is a social security benefit (i.e. a taxable portion of a claimant’s gross income).

The example cited by courts and included in legislative history is: “if an individual is entitled to $10,000 of social security disability benefits but received only $6,000 because of the receipt of $4,000 of workmen’s compensation benefits, then, for purposes of the provisions taxing social security benefits, the individual will be considered to have received $10,000 of social security benefits.”

Accordingly, the tax due on the receipt of social security disability benefits is based upon the total amount of social security benefits to which a claimant is entitled, whether or not an offset causes a portion of that amount to be reduced because of the receipt of workers’ compensation benefits.  As such, when an offset exists, workers compensation benefits could be taxed as if they were social security benefits.

Note: Jones Act payments are not workers compensation, and they do not offset.