The short answer is no.
Benefits received through workers’ comp program (…be it in Colorado or elsewhere) are not subject to both federal and state taxes. They are not taxed for a variety of reasons – one of them being the fact that they’re not considered “earned income” under tax laws.
This generally applies to both weekly wage loss and any lump sum payments.
The thinking goes something like this – when you’re injured on-the-job and out of work, you will likely have to miss work. Any benefits you receive for lost wages are at a reduced rate from your normal pay.
Therefore, the IRS and the Colorado Legislature rightfully claim that it would be grossly unfair and unjust to require you pay taxes on these benefits.
The tax exemption also applies to benefits paid to any survivors (…workers’ comp death benefits).
However, if you return to work in a modified role during your recovery, any earnings from your job will be taxable since they are indeed “earnings” from working. The workers’ comp wage loss benefits you’re still receiving will not be taxed though.
While the answer to the question above is pretty straight forward for regular workers’ comp benefits, it gets a little vaguer if your benefits are combined with social security disability (SSDI) or some retirement plan.
In short, any supplemental benefits you receive through SSDI or another plan will be taxable at the applicable rate.
Any pension based on your age, years of service, etc. etc. is taxable. However, if part of that plan is paid through workers’ compensation, that part will NOT be taxed.
Some clarity on the relationship between SSDI and workers’ comp and taxes was handed down by a U.S. Tax Court in 2011. Their decision was based on whether workers’ comp benefits can be excluded from taxable income.
The case in question (…here in Colorado in fact) involved Linda Sherar. Mrs. Sherar sustained two major injuries requiring her to undergo 12 separate surgeries. She started receiving workers’ comp benefits in 1999 and applied for SSDI in 2003. Although her initial application was denied, she eventually started receiving SSDI benefits in 2007.
When she received a statement from the Social Security Administration though, Linda discovered a “workers’ compensation offset” but did not report any SSDI benefits as income. The IRS claimed that 85% of the SSDI benefits she received should have been included on her tax return as income.
While the tax court recognized the workers’ comp benefits as being NOT taxable, they concluded that SSDI benefits may “…be includable in a taxpayer’s gross income pursuant to a statutory formula.”
They claimed that under section 86(d)(3), the amount of SSDI benefits may include the amount of workers’ compensation benefits received. Meaning that “if the amount of Social Security benefits that a taxpayer receives is reduced because of the receipt of workers’ compensation benefits, there is what’s called and offset.”
With this offset, “the amount of workers’ compensation benefits that cause the reduction is treated as though it were a Social Security benefit.”
Therefore, be careful when considering your options regarding SSDI and permanent disability.
Of course, you should consult with an account or an experienced workers’ comp attorney in Colorado to ascertain what, if any taxes you will be responsible for. DO NOT take this post or any other information you find online for granted. Do your own research and discuss your individual situation with a qualified professional.
In the end though, if you’re receiving straight workers’ comp benefits paid out by your employer’s insurance company, you DO NOT have to pay any taxes on those funds you receive.