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Is Workers Comp Taxable in Pennsylvania: The Short Answer and the Exception

Benefits are generally not taxed. The exception involves Social Security Disability.

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Kenneth R. Schuster, founding member of Schuster Law
Kenneth R. Schuster Founding Member. Practicing in Delaware County since 1982.

Pennsylvania workers compensation benefits and Compromise and Release settlements are generally not subject to federal or state income tax. The significant exception is where you also receive Social Security Disability: the portion of your compensation that causes an offset to those benefits can become taxable.

The general rule

Workers compensation wage loss benefits are generally not taxable income, federally or in Pennsylvania. Neither is a lump sum Compromise and Release settlement of a compensation claim. Medical benefits paid on your behalf are not income to you either.

This is one reason the “about two thirds of wages” figure lands closer to your normal take home pay than the fraction suggests. You are comparing an untaxed benefit against a taxed wage.

The Social Security offset exception

If you receive Social Security Disability at the same time as workers compensation, your Social Security benefit may be reduced so the combined total does not exceed a set proportion of your prior earnings. That is the offset.

The portion of your workers compensation that causes the offset can be treated as Social Security income for tax purposes, and Social Security income is taxable above certain thresholds. In practice most people in this situation still owe little or nothing, because their total income is low. It is nonetheless the exception worth knowing about rather than being surprised by.

How a settlement can be structured to help

A Compromise and Release that allocates the lump sum over your expected lifetime, rather than treating it as received all at once, can reduce the offset. This is a routine and legitimate piece of drafting, and it is one of the practical reasons the wording of a settlement matters as much as the number.

It has to be done in the agreement itself. It cannot be fixed afterwards.

What is taxable

  • A third party injury settlement is a different question with different rules, and interest on it is generally taxable.
  • Wages for light duty work are ordinary taxable income, even where compensation tops them up.
  • Unemployment compensation, if you receive it, is taxable.
  • Retirement or pension income is unaffected by any of this.

Please do not take this as tax advice

We are not accountants, and your situation may have features this page does not contemplate. What we can do is tell you how the settlement should be structured so it does not create a problem, and then say so plainly in the agreement. Anyone receiving both compensation and Social Security should speak to a tax preparer before signing.

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Questions people ask us about this

Do I pay tax on Pennsylvania workers compensation?

Generally no. Wage loss benefits and a Compromise and Release settlement are normally not subject to federal or state income tax, and medical benefits paid on your behalf are not income to you. This is part of why the two thirds figure feels closer to your usual take home pay.

What is the Social Security offset exception?

If you receive Social Security Disability at the same time, your Social Security benefit may be reduced so the combined total stays within a set proportion of prior earnings. The part of your workers compensation causing that offset can be treated as Social Security income, which is taxable above certain thresholds.

Can a settlement be written to reduce the offset?

Yes. Allocating a lump sum over your expected lifetime within the Compromise and Release, rather than treating it as received in a single year, can reduce the offset. It is routine drafting, it is legitimate, and it has to be in the agreement itself because it cannot be corrected later.

Is my third party injury settlement taxable too?

That is a separate question with different rules, and interest on such a settlement is generally taxable. If you have both a compensation claim and a third party claim, the tax position should be looked at across both rather than one at a time.

Do I have to report workers comp on my tax return?

Reporting requirements differ from taxability, and your circumstances may include features this page does not cover. We are lawyers rather than accountants. Anyone receiving both compensation and Social Security should speak to a tax preparer before signing a settlement.

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