Do I Have to Pay Taxes on Workers' Compensation Benefits?

Workers' compensation benefits you receive for a work-related illness or injury are generally not taxable at the federal level and don't need to be reported as income on your federal tax return. This exclusion applies to amounts paid under any workers' compensation law — regular benefit payments, lump-sum settlements, and payments for medical expenses are all treated the same way. However, there's a partial exception if you're also receiving Social Security Disability Insurance (SSDI) or Supplemental Security Income (SSI) benefits at the same time: if your workers' comp causes your Social Security disability benefits to be reduced (which can happen under a coordination rule), the portion of Social Security benefits that replaced the workers' comp reduction may become taxable. Additionally, if you return to work in a light-duty capacity while receiving workers' comp, the wages from that light-duty work are fully taxable even though the workers' comp benefits aren't. Most states also exempt workers' compensation from state income tax, but you should verify your state's rules.