Most states do not tax workers' compensation, but a handful do
Workers' compensation benefits are tax-free in 44 states and Washington, D.C. Six states — Illinois, Indiana, Kentucky, Louisiana, Mississippi, and New Mexico — tax a portion of workers' compensation income. The amount taxed and the conditions under which it is taxed vary by state, so the tax burden depends on where you work and live, not just where you were injured.
If you receive workers' compensation in one of the six taxing states, you will report the taxable portion on your federal income tax return. The state may also require you to file a state return. The tax is calculated on the gross benefit amount before any deductions, though some states offer partial exemptions or allow deductions for certain types of benefits.
Key Takeaways
- Illinois, Indiana, Kentucky, Louisiana, Mississippi, and New Mexico are the only states that tax workers' compensation benefits.
- The amount taxed varies: some states tax all benefits above a certain threshold, while others tax only specific types of payments.
- Federal workers' compensation and federal employees are not subject to state taxation of these benefits.
- If you live in a non-taxing state but work in a taxing state, the state where you work typically determines whether the benefit is taxed.
- You should report the taxable portion on both your federal return and your state return if required.
Illinois taxes workers' compensation above a threshold
Illinois taxes workers' compensation benefits that exceed $30,000 per year. Only the amount above that threshold is subject to state income tax. This means if you receive $35,000 in annual workers' compensation, only $5,000 is taxed.
The $30,000 threshold applies to the calendar year, so if you receive a lump-sum settlement in one year, the entire amount counts toward that year's threshold. If the settlement spans multiple years through structured payments, each year is calculated separately. You will report the taxable portion on your Illinois state income tax return.
Indiana, Kentucky, Louisiana, Mississippi, and New Mexico tax all or most benefits
Indiana taxes all workers' compensation benefits as ordinary income with no threshold or exemption. The full amount you receive is subject to state income tax.
Kentucky taxes all workers' compensation benefits. Louisiana taxes benefits received as income replacement (wage-loss payments) but not medical benefits or permanent disability awards. Mississippi taxes all workers' compensation income. New Mexico taxes workers' compensation benefits, though certain types of awards may receive different treatment depending on whether they are for wage loss, permanent disability, or other categories.
The specific rules in each state can be complex, particularly around lump-sum settlements and structured payments. If you receive benefits in one of these states, contact your state tax authority or a tax professional to understand exactly what portion of your benefit is taxable and how to report it.
Where you work, not where you live, usually determines the tax
If you work in a state that taxes workers' compensation but live in a state that does not, the state where you were injured and received the benefit typically has the right to tax it. Your home state generally will not tax the benefit, but you may still need to report it on your state return depending on your state's rules.
The opposite situation — working in a non-taxing state but living in a taxing state — is simpler: your home state cannot tax a benefit that is not taxable in the state where it was earned. However, you should verify this with your state tax authority, because residency rules vary.
Federal workers' compensation is never taxed by states
If you receive workers' compensation through a federal program — such as the Federal Employees' Compensation Act (FECA), the Longshore and Harbor Workers' Compensation Act (LHWCA), or the Black Lung Benefits Program — those benefits are exempt from state income tax in all 50 states. This exemption applies regardless of which state you live in or where you work.
Federal benefits are also exempt from federal income tax, so you will not report them on your federal return either. If you receive both state workers' compensation and federal workers' compensation, only the state portion may be taxable.
How to report taxable workers' compensation on your tax return
Workers' compensation benefits are reported on IRS Form 1040 (your federal return) on the line for "other income" or in the section for workers' compensation, depending on the year and form version. Your employer or the workers' compensation insurance carrier will send you a Form 1099-R or similar statement showing the gross amount paid.
If your state taxes workers' compensation, you will also report the taxable portion on your state income tax return. The form and line vary by state — some states have a specific line for workers' compensation, while others require you to report it as ordinary income. Check your state tax authority's website or contact them directly to confirm where to report the amount.
If you received a lump-sum settlement, the entire amount may be reported on a single form in the year you received it, even if the injury occurred in a previous year. This can push you into a higher tax bracket in that year. Some states allow you to average the income over multiple years to reduce the tax impact, though this is not automatic — you may need to request it.
Deductions and exemptions vary by state
Some states allow you to deduct attorney fees or settlement costs from the taxable amount before calculating tax. Others do not. Illinois, for example, does not allow deductions — the tax is calculated on the gross benefit before any costs are subtracted.
A few states exempt certain types of awards from taxation. Louisiana, for instance, does not tax medical benefits or permanent disability awards — only wage-loss payments are taxed. New Mexico distinguishes between different types of awards as well. If you are unsure whether your specific benefit qualifies for an exemption, contact your state tax authority or review the workers' compensation section of your state's tax guide.
Frequently Asked Questions
Do I have to pay federal income tax on workers' compensation?
No. Workers' compensation benefits are exempt from federal income tax, whether they come from a state program or a federal program. You do not report them on your federal return unless you live in one of the six states that tax them — in that case, you report only the state-taxable portion on your federal return as well.
What if I received workers' compensation years ago and am just now being asked about it on my tax return?
If you received the benefit in a non-taxing state, you owe no tax on it. If you received it in a taxing state and did not report it, you may owe back taxes plus interest and penalties. Contact a tax professional or your state tax authority to discuss your options, which may include filing an amended return.
Does a workers' compensation settlement count as income for other purposes?
For most government programs, workers' compensation is not counted as income — it does not affect Social Security benefits, Medicare, Medicaid, or most means-tested programs. However, some programs have their own rules, so check with the specific program if you are concerned about how a settlement might affect your benefits.
If I move to a different state after receiving workers' compensation, do I owe tax in my new state?
No. The state where you were injured and received the benefit determines the tax treatment. Moving to a different state does not change whether the benefit is taxable. However, if you move from a non-taxing state to a taxing state, you do not owe tax to your new state on benefits received before you moved there.
How do I know if my state taxes workers' compensation?
Check your state tax authority's website or call their helpline. You can also ask your workers' compensation insurance carrier or employer — they often know the tax rules for your state and can point you to the right resources. A tax professional in your state can also confirm the rules and help you file correctly.