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Do I Have to Pay Tax on my Benefit Payments or Personal Injury Settlement?

At tax time, clients often ask us if they will owe tax on their weekly benefit payments or personal injury settlement.

The short answer is no, you generally do not have to pay tax on Vermont workers’ compensation benefit payments or personal injury settlements. That’s right, in most cases these are not taxed. Great news! BUT…Social Security Disability benefits are taxed, and the amount of tax you have to pay can change depending on certain factors. Read on for more detailed information that could help you with your tax return.

Tax on Vermont Workers’ Compensation and Personal Injury Payments

Vermont workers’ compensation benefit payments and personal injury settlements are not taxed because they are paid due to an injury. While it’s great that you don’t have to worry about taxes reducing the money that may be keeping you afloat after an injury, there are a few things to be aware of.

  1. You can’t claim this money as “earned income” and get an Earned Income Credit.
  2. Because workers’ compensation benefit payments are considered to be “unearned income”, they could affect any property tax abatement or renter rebate you apply for.
  3. If you are getting both workers’ compensation benefits and Social Security disability benefits, your SSDI benefits might be offset (reduced) and might then also be taxed. This is complicated but here’s the bottom line: if workers’ compensation is offsetting your SSDI, you may have to pay tax on SSDI you aren’t even receiving! Don’t let this happen to you. Talk to an experienced workers’ compensation attorney or disability attorney if you receive both workers’ compensation and disability benefits. These kinds of cases can be complex and we can share what we have learned to help you get the most money you can and avoid being taxed.

Tax on Social Security Disability Payments

In Vermont, Social Security disability benefits are taxed, but not in the same way as most other income. The amount of tax you will pay depends on three things: whether you have other taxable income, whether your benefits cover more than one tax year, and whether you also received workers’ compensation benefits.

1. Do you have other sources of income?

Here’s a general guideline: if Social Security benefit payments are your only source of income, then it is not taxed and you likely do not need to file a federal income tax return. If you have other income, a portion of your Social Security benefits may be taxed. For more information, view the Social Security Administration’s Benefits Planner.

2. Do your Social Security benefits cover more than one tax year?

Another factor that can affect how much tax you pay is whether you received a large lump-sum check for retroactive benefits that could cover more than one year. Because Social Security benefit payments can sometimes be taxed, the SSA sends a 1099 form to everyone who gets benefits. When you get one of these, it is always best to consult with a tax specialist—such as a certified public accountant (CPA) or a lawyer who specializes in tax issues—to see if you will owe tax on any portion of that amount. If the 1099 includes money that was paid as retroactive payments for previous years, then the specialist will probably want to see the notice of award which SSA sends you explaining how they calculated your benefits.

3. Did you receive both workers’ compensation and Social Security benefits?

A third and final issue that sometimes confuses people is when you have received workers’ compensation benefits and Social Security benefits at the same time. In this situation, the 1099 form may include money that the Social Security Administration (SSA) never actually paid you. This is because workers’ compensation benefits may have reduced the amount of Social Security benefits that can be paid. This can result in you getting taxed on SSDI that you aren’t even receiving! This situation can be very complicated and it’s best to talk to an experienced workers’ compensation attorney or disability attorney if you receive both workers’ compensation and disability benefits.

If you are in any doubt about whether you owe tax on your workers’ compensation benefit payments, personal injury settlement, or Social Security benefits, be sure to talk to a CPA, a tax attorney, or a free tax preparation service such as the IRS’s Volunteer Income Tax Assistance program or the AARP’s Tax-Aide program.

Your 2017 tax return is due April 17, 2018, so be sure to get in touch with an expert soon if you have questions.