Disability Awards & Payments, Taxable or Not?

It is that time of year again, the beloved tax season. The time of year when people scramble to find all tax records and documents to file before the April 15th deadline. Filing taxes usually raises questions about what qualifies as taxable income. Does a settlement from a personal injury claim qualify as taxable income? How about payments from the Department of Labor and Industries? These are significant questions as most of us begin to receive tax documents like W-2s, 1098s and 1099s. The good news is that payments to compensate for bodily injury are generally not taxable forms of income.

While most things are taxed today, disability payments generally are not. This is because disability payments are meant to compensate for a loss and are not considered income, such as wages, salaries or tips. This article is to help shed some light on how personal injury settlements and payments from the Department of Labor and Industries are treated for tax purposes.

Personal Injury Settlements/Compensation
Proceeds received from a personal injury claim are not taxed if the payments are to compensate for physical injuries or emotional distress caused by physical injuries. These payments are not earned income but compensate you for a loss. Form of payment does not affect the classification, as neither lump sum nor periodic compensatory payments are taxable. However, there can be some portions of a personal injury award that can be considered income.

Claims for emotional harm without any physical harm;
Interest earned on an award;
Reimbursed wages; and
Punitive damages

A quick discussion with your personal injury attorney or an accountant will likely be helpful if you received any of the above awards.

Workers’ Compensation
Payments received from the Department of Labor and Industries are general not considered taxable income either. During the course a workers’ compensation claim, several types of payment may be received. The most common form of payment is time-loss. Time-loss payments are intended to compensate an individual for an inability to work due to an injury on the job. This is not earned income and is not taxable because the IRS considers these disability payments. However, returning to work and earning wages or salary during or after a claim is taxable income and should be reported.

Another form of payment made by the Department of Labor and Industries is a permanent partial disability payment. Permanent partial disability payments are based on loss of bodily function due to an injury. Neither lost wages nor pain and suffering are considered when awarding these payments. Similar to personal injury awards, permanent partial disability payments are not generally taxable whether paid in a lump sum or in periodic payments.

A final form of payment made by the Department of Labor and Industries is pension or permanent total disability payments. When an injured worker is seriously injured and unable to return to work at any time in the future, pension may be granted by the Department. Pension payments are intended to compensate an individual for an inability to work for the remainder of their life. So, pension payments are not generally taxable. The Department of Labor and Industries does not withhold taxes from pension payments or send out any 1099 or W-2s. Do not worry if you do not receive these documents from the Department.

However, if you are receiving social security disability payments and workers’ compensation payments and you are between the ages of 62-65, you may be in the reverse offset time-period. During, this time period, social security is offset by workers’ compensation payments. The workers’ compensation payments that offset the social security payments are considered taxable as social security benefits. If you find yourself in this category, speaking with a knowledgeable accountant could be very beneficial.

Tax season can be a difficult and confusing time of the year, especially with the new changes in the tax law. Be sure to speak to an experienced accountant about any questions you may have. You can also find additional information through the IRS website – www.IRS.gov.

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