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Are workers’ compensation benefits taxable?

On Behalf of | Mar 17, 2023 | Workers' Compensation |

How about the interest or penalties?

It is well recognized that workers’ compensation benefits are not subject to income taxes. However, some insurance companies issue 1099 forms and/or report as taxable the award of interest and penalties to the state or Federal government. The issue is still subject to debate, as there appears to be no case law directly ‘on-point’.

By way of background, the Pennsylvania Workers’ Compensation Act provides a variety of benefits an injured worker might be awarded. In addition to the typical wage loss and medical benefits, other types of workers’ compensation awards include Specific Loss (for the loss of a body part or permanent scar from the neck up); Penalties (where the employer or insurance company is found to have violated the law in some manner); Fatal Claim benefits (to the surviving spouse or dependent heirs of worker killed in the course of their employment); and a few others. Interest is required to be paid when there is any delay in payment of benefits the injured worker is entitled to receive, called Statutory Interest.

The Federal (United States) tax code [The Internal Revenue Code] states that gross income means “all income from whatever source derived”, and is subject to taxes, except for specifically enumerated exclusions. The Code then expressly excludes “amounts received under workmen’s compensation acts as compensation for personal injuries or sickness”. 26 U.S. Code §104(a)(1). Other types of personal injury awards are also not subject to income taxes. The specific, exact wording is extremely significant.

In a 1993 Wrongful Death/Personal Injury claim, the plaintiff was awarded “damages”, along with interest. The Court held that the portion of the award for damages is not taxable, but the interest is taxable. Kovacs v. Commissioner of Internal Revenue, 100 T.C. 124 (U.S.T.C. 1993). Some workers’ compensation insurance companies issue 1099 forms for the Statutory Interest paid to a workers’ compensation claimant, relying on that case, and other case law suggesting (but not expressly Holding) that interest in workers’ compensation claims should be treated the same way as in Kovacs.

However, as stated above, the EXACT WORDING of the Internal Revenue Code is significant.

26 U.S. Code §104(a)(1). Compensation for injuries or sickness

(a) In general… gross income does not include:

  1. amounts received under workmen’s compensation acts as compensation for personal injuries or sickness;
  2. the amount of any damages (other than punitive damages) received (whether by suit or agreement and whether as lump sums or as periodic payments) on account of personal physical injuries or physical sickness

There is distinct difference in the way the government described each type of award. For workers’ compensation claims, the exclusion applies to “amounts received under workmen’s compensation acts as compensation… ”  By comparison, the exclusion regarding personal injury claims applies specifically, and by limitation to “the amount of any damages”. Where a statute uses broad, all-inclusive words to describe the exclusion for workers compensation, and different, limiting words to describe personal injury awards, the Rules of Statutory Interpretation require the Court to apply the intent of the differing terms. In fact, the government re-emphasized the different scope of each exclusion in their publications.

Other Payments

You may receive other payments that are related to your disability. The following payments aren’t taxable.

  • Benefit payments from a public welfare fund, such as payments due to blindness.
  • Workers’ compensation for an occupational sickness or injury if paid under a workers’ compensation act or similar law.
  • Compensatory (but not punitive) damages for physical injury or physical sickness.
  • Disability benefits under a “no-fault” car insurance policy for loss of income or earning capacity as a result of injuries.
  • Compensation for permanent loss or loss of use of a part or function of your body, or for your permanent disfigurement.

Insurance companies may argue that the full sentence regarding the workers compensation exclusion is limited by the phrase “as compensation”; but the definition of interest includes ‘compensation’ for the person’s loss of use of the money during the period of time the principle payment is delayed or withheld. It is a type of compensation. By comparison (again), the exclusion for personal injury awards is expressly limited to the “damages” and does not include broad language to encompass other types of “compensation”. In fact, the Kovacs Court themselves defined the terms damages and interest:

“The term ‘damages’ connotes the ‘compensation or satisfaction imposed by law for a wrong or injury’. Webster’s Third New International Dictionary (1986). The word ‘interest’ in this context means ‘the price paid for borrowing [i.e., withholding] money’. Id. ” Kovacs v. Commissioner of Internal Revenue, 100 T.C. 124, 128 (U.S.T.C. 1993)

The payment of interest is to compensate the person owed money for the time that money is withheld.

Pennsylvania’s Tax Code (72 P.S. §7301 et seq.) applies virtually identical exclusions, stating “All other payments received under workers compensation acts is not taxable compensation.”

Payments received under worker’s compensation acts, occupational disease acts, or similar legislation, including payments for injuries you received while working, and damages received, whether by suit or otherwise, for personal injuries (unless one is required to pay these monies back to the employer and receives regular salary in return) are taxable when the employee must turn over the worker’s compensation payments to the employer in order to receive his or her regular salary in return. The employee does not report the worker’s compensation payments, but does report the full amount of his or her regular salary. All other payments received under workers compensation acts is not taxable compensation. Occupational disease acts are not taxable.

It is the strong opinion of Schmidt, Kirifides & Rassias that interest payments made on delayed workers’ compensation benefits is NOT taxable. We zealously fight to protect our client’s interest against insurance companies who seek only profits and increased revenue – at the expense of injured workers. For a free, no obligation consultation, call us at 610-601-5399 or reach out to us online.