If the total amount of Social Security Disability Insurance (SSDI) and WC monthly payments exceeds 80% of the claimant’s (monthly) Average Current Earnings, then the SSDI payments are reduced by the amount exceeding the 80% threshold. Under the current tax code, workers’ compensation benefits are generally not taxable, but SSDI payments are taxable using a statutory formula that take a variety of factors into account. So what is the tax status of the set-off amount? Is it tax-free as a workers’ compensation payment or taxable as a SSDI payment?
The U.S. Tax Court recently addressed this issue in Sherar v. IRS. Even though the decision creates no binding authority or precedent, it did contain some startling revelations involving the tax status of workers’ compensation benefits for a claimant also receiving SSDI payments. The Court ruled that the set-off amount of workers’ compensation benefits is treated as though it were a SSDI benefit and, therefore, taxable. The Court’s rationale behind the decision was the legislative intent behind the relevant portion of the tax code, which the Court determined to be "to equalize the Federal tax treatment of Social Security benefits that are received by taxpayers who may or may not be eligible to receive workers’ compensation benefits."
My Two Cents:
Part of the set-off calculation contains a threshold that the total benefits must reach before the set-off must occur. If a claimant’s settlement is structured correctly, the claimant could, in theory, avoid the set-off completely. If not, claimants currently on disability or who wish to apply for disability will have to consider the tax implications and interplay between workers’ compensation and SSDI benefits.