Are you ready to prepare your small business taxes? Have you paid workers’ compensation to an employee? Do you pay workers’ compensation premiums monthly? Are you taxed on workers’ compensation? What do you need to know about workers’ compensation and taxes?
As tax specialists, we get a lot of questions on how workers’ compensation affects both business and personal tax returns. Workers’ compensation is created to help protect employees.
If you are an employer, you may be liable to pay workers’ compensation if your employees get hurt or sick from their job. These benefits are not taxable. However, other benefits may cause a portion of the worker’s comp to be taxed.
Regardless of your situation, you should know what workers’ comp covers and the tax implications. The correct knowledge can help you prepare for tax time and save money.
Taxes and Benefits for Workers’ Compensation
Unless you live in Texas, you will be required to have workers’ compensation insurance. This insurance can help pay for an illness that is directly caused by work or injuries that occurred on duty, as well as ongoing costs or lost wages related to these incidents.
It can further cover disability and even funeral costs. When considering who qualifies for workers’ compensation, fault is not usually a factor.
You can visit the U.S. Department of Labor’s state workers’ compensation system to find an agency near you.
Your employees may also question whether workers’ compensation is subject to payroll tax. The short answer is no. Regardless if your employee is receiving benefits related to a cut, a broken bone, a muscle strain, or a long-term injury such as tendinitis or carpal tunnel, generally, workers’ comp is not taxable.
Workers’ compensation benefits are paid out at ⅔ the rate of normal wages generally. Because of this, it comes close to the same amount an employee would have received post-taxes on full wages. IRS Publication 907 provides more information on the non-taxable status.
The Importance of Workers’ Compensation Insurance
While most states require workers’ compensation insurance, it is a good thing to have as an employer. This insurance helps prevent costly lawsuits in the event of injury claims. Overall, it helps improve the environment and relationship between employees and employers.
The best benefit for employers is that this insurance protects the employer from having to pay medical costs and lost wages. Workers’ compensation is only for employees and does not cover contractors, nor is it required for third parties.
For employees, workers’ comp helps establish a safer work environment. It allows employees to work confidently, knowing they will be covered in the event of injury.
When is Workers’ Compensation Tax Deductible?
The premiums you pay for workers’ compensation insurance are deductible as an employer. You may qualify to deduct the benefits, payments, and premiums from your workers’ compensation insurance.
Workers’ compensation insurance qualifies as an ordinary expense and is considered necessary by law.
The IRS guide to business deductions gives a more solid picture of the tax implications. You should consult a tax specialist to learn more about filing your taxes and including your workers’ comp premium.
Small businesses seeking to claim their premiums for federal taxes need to submit an IRS form Schedule C. These expenses are recorded with other business expenses such as utilities and rent.
When is Workers’ Compensation Taxable?
While workers’ compensation income is not taxable by state or federal entities, you will still receive a W-2. Workers’ compensation benefits are still considered an income. This is important to remember when applying for state benefits due to low income.
An employee can receive both medical benefits and lost wages benefits. Medical benefits are not considered income as these are paid directly to the medical provider.
If an employee is receiving SSDI (Social Security Disability Insurance), SSI (Supplemental Security Income), or retirement benefits, their workers’ comp may be taxable. These programs are not for temporary disability; therefore, most workers’ compensation cases will not be affected.
Each state has different requirements. Encourage your employees to research your state’s individual regulations. Be smart in preparing your tax returns and know if you are affected by these conditions.
Social Security may reduce your monthly payments when you receive both benefits to ensure that earnings are at most 80% of your previous wages.
The Effect of Retirement Benefits on Workers’ Comp
If you retire because of your injury or illness related to your job, your retirement benefits will become taxable. This will also apply if your workers’ compensation benefits lower your social security benefits.
The Effect of Offset on Workers’ Compensation
The taxes you pay may become an issue when there is an offset. A portion of any Social Security benefits is taxed when you reach a certain income.
If your Social Security benefits are reduced because of workers’ comp, the amount that was subject to offset may be taxed even though it was received from workers’ compensation benefits.
The logic behind this conclusion is that the amount of offset would have been taxable if you had received it from Social Security anyways. An example of this is if you qualified for $2400 in SSDI benefits and $1500 in disability. The total is $3900, and your previous income was $4300. The total in benefits is 90% of your wages and cannot exceed 80%.
In this circumstance, your SSDI would be reduced by $460. This income is still taxable, although it is paid from workers’ comp benefits.
You should now have a solid idea of whether workers’ compensation is taxable and the benefits associated with it.
Tax season is just around the corner, and you don’t want to be caught with unacceptable tax filing mistakes. Workers’ compensation and taxes can be a sticky situation! A tax expert like Sherry Borshoff can help you navigate the regulations and protect your business.
Contact us today for a free consultation. We vow to answer your questions honestly and ethically. We can calculate your business’ specific rate and help meet all the tax requirements.