Should I Take a Full and Final Settlement or Structured Payments?
Being injured on the job presents difficulties to those affected—namely that they no longer have the ability to work and bring a paycheck home to their family. Luckily, workers’ compensation can offset such injuries.
Like other types of insurance settlements, injured workers generally have the option of receiving a lump sum payout or a structured settlement (typically weekly, monthly or yearly) in cases of serious injury. As we discuss below, each settlement type has its pros and cons.
Full and Final Settlements
An injured worker can try to settle their workers’ compensation case on a full and final basis at any point during the pendency of the claim. A full and final settlement is exactly what it sounds like: The injured worker agrees to close their claim permanently and, therefore, permanently cut off the insurance company’s responsibility for any future benefits in exchange for an agreed-upon amount of money.
Example response and counter-offer letter to an insurance settlement that is too low. How to negotiate a settlement with your insurance company for your personal injury and accident claim.
Settlements are voluntary for both sides.
You can only settle a case if the other side is willing to negotiate a settlement. There is no way to force them to do so. Because a settlement relieves the carrier of any responsibility for additional benefits (or any benefits in the case of a completely denied claim), the amount of any settlement is a reflection of the cost of what benefits an insurance carrier might have to pay in the future if the claim is not settled and the chances that they will have to pay for those benefits.
If a claim is completely denied and you try to settle a case to avoid the risk of losing a hearing and getting nothing, the amount of that settlement would be based on what the entire case could cost the insurance carrier if they lose the hearing. A settlement in that situation could include the cost of wage loss benefits (called temporary disability benefits), medical benefits and permanent disability benefits (as well as other benefits that sometimes apply in these cases). Often in these cases, the settlement is only based on potential additional permanent disability benefits and medical benefits.
Regardless, full and final workers’ comp settlements are almost always paid out in a lump sum (i.e., all at once).
People occasionally decide to “structure” settlement payments in serious, catastrophic cases rather than getting a lump sum payout. A structured settlement (also known as a “structured annuity”) is guaranteed payments at a predetermined interval, either for a certain period of time or for the rest of a person’s life.
The structured settlement is not something that is provided by the insurance carrier involved in the claim. The insurance carrier involved in the claim still pays the entire settlement upfront, but then the structured settlement is purchased with the settlement monies paid by the workers’ compensation carrier in the claim from another financial company.
In serious cases, a claimant may choose structured settlements for 2 reasons:
- Structured settlements are usually guaranteed for life. Thus, in serious cases, it can provide a guaranteed source of income for the rest of the person’s life to pay for medical treatment and living expenses no matter how long they live. Structured settlements avoid the risk of the injured worker “blowing” the money all at once.
- Structured settlements have huge tax benefits. Settlements paid in a workers’ compensation case are not taxed. If, however, you take a large settlement in a lump sum and invest the money on your own, all of the earnings on the money are taxed. If you do a structured settlement, however, then the financial company you purchased the structured settlement from invests the money and provides a return on your money. In short, you get a better return on the money because of the tax-free benefit.
However, there are some drawbacks to structured settlements, too. The main disadvantage is that scheduled payments are mostly locked in once you agree to the structured settlement. In other words, you can’t change your mind in the future and get a lump sum payout without significant penalties.
Is a workers’ comp settlement taxable?
A few related questions our Colorado attorneys frequently get asked during the course of settlement negotiation and mediation of a workers’ compensation case are:
- Am I going to get taxed on the final settlement amount?
- Do I have to claim workers’ comp benefits as income when filing taxes?
- Are workers’ comp settlements taxable?
The short answer to all of these questions is no.
As with personal injury claims, benefits received through a state’s workers’ comp program (be it in Colorado or elsewhere) are not subject to either federal or state taxes. They aren’t taxed for a variety of reasons— one being the fact that they’re not considered “earned income” under current tax laws.
According to the IRS’s Publication 907, “Workers’ Compensation for an occupational sickness or injury if paid under a Workers’ Compensation act or similar law” is not taxable.
This generally applies to both structured weekly wage loss and lump sum payments.
The reasoning behind not taxing workers’ comp settlements goes something like this:
When you’re injured on the job and out of work, you’ll 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 injured workers to pay taxes on those benefits.
This tax exemption also applies to benefits paid to any survivors under workers’ comp death benefits.
FAQ regarding taxation of your workers’ comp benefits
No. By federal law, workers’ compensation benefits can’t be taxed. Therefore, these benefits are not taxed by most states and do not need to be reported when you file taxes.
Unless your lump-sum payment includes interest, no part of it is taxable—federally or by the state—in most cases. If your lump-sum payment does include interest, the interest portion can be taxed.
No. Neither is needed.
Exceptions: When workers’ comp benefits CAN be taxed
If you return to work in a modified role during your recovery, keep in mind that any earnings from your job will be taxable since they’re 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 straightforward for regular workers’ comp benefits, it gets slightly more vague and confusing if your benefits are combined with Social Security disability (SSDI) or some retirement plan. In short, any supplemental benefits you receive through Social Security Disability Insurance (SSDI), Supplemental Security Income (SSI) or another plan will be taxable at the applicable rate.
When an injured worker also receives disability benefits SSDI or SSI, the Social Security Administration (SSA) may reduce the individual’s SSDI or SSI payouts so that the combined amount of the workers’ comp benefits and the disability payments remains below a certain threshold. This is known as a “workers’ compensation offset.”
So, if SSA reduces your monthly SSDI check by $200 due to the workers’ compensation offset, then $200 of your workers’ comp will be taxable.
Any pension based on your age, years of service, etc., is also taxable. However, if part of that plan is paid through workers’ compensation, that part will not be taxed.
U.S. court rules that injured worker benefits cannot be taxed
Some additional clarity on the relationship between SSDI, workers’ compensation, 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 took place right here in Colorado and involved Linda Sherar. Mrs. Sherar sustained 2 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.
But when she received a statement from the Social Security Administration, Linda discovered a “workers’ compensation offset” but didn’t 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 an 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.
If you or a loved one are injured at work or diagnosed with an occupational disease, you are likely entitled to certain benefits under the Colorado Workers’ Compensation Act…
Seek Legal Counsel Immediately
So to recap, your workers’ comp benefits are generally not taxable, but certain situations can cause your benefits to be taxed. Regardless of which workers’ comp payment option works best for your situation, being injured in the course of performing your job entitles you to workers’ compensation benefits. If you need guidance on the best way to receive your injury benefits, we strongly advise consulting a knowledgeable workers’ compensation lawyer as soon as possible.
If you were injured in Colorado, the work injury legal team at The Babcock Law Firm wants to talk to you. We can discuss your case and come up with a solution that works best for you and your family.
Continue reading these related articles for more information…
- Benefits Available Under a Workers’ Compensation Claim
- Resolve Colorado Personal Injury and Workers’ Compensation Disputes Out of Court
While The Babcock Law Firm tirelessly works to obtain successful outcomes for its clients, prior positive outcomes are no guarantee of future success. Indicating prior positive results is in no way intended to guarantee future results.