Do You Need to Report a Workers’ Comp Settlement on Your Taxes?

Updated on February 17, 2026

If you received workers’ compensation benefits or a settlement in California, you may be wondering: Do I have to report this on my taxes?

For most injured workers, the short answer is No. Workers’ compensation benefits are generally not taxable. However, there are important exceptions and financial considerations you should understand before filing.

This updated 2026 guide explains when workers’ comp is tax-free, when taxes may apply, and what steps you should take to protect yourself.

Quick Answer (2026)

In California, most workers’ compensation benefits and settlements are not subject to federal or state income tax, including:

Temporary disability payments

Permanent disability payments

Medical treatment and future medical settlements

Lump-sum settlements related to injury

Job retraining and return-to-work benefits

However, certain portions may be taxable if your case includes back wages, SSDI offsets, or interest.

Who This Applies To

This guide is for injured workers in California who:

Are receiving temporary or permanent disability payments
Settled their workers’ comp case (C&R or Stipulated Award)
Received a lump-sum settlement
Are also receiving Social Security, EDD, or other benefits
Are preparing to file taxes and want to avoid mistakes

Why Workers’ Comp Benefits Are Usually Not Taxable

Workers’ compensation is considered a benefits delivery system, not an income system.

According to California and federal tax rules:

Workers’ comp is not treated as wages
It is classified as social insurance or personal injury compensation
It is meant to support recovery, not generate profit

Even temporary disability, which replaces part of your wages, is calculated in a way that already accounts for taxes. You are not receiving gross pre-tax income.

That is why:

Temporary disability
Permanent disability
Medical care
Future medical buyouts

are all generally tax-exempt.

For more information, watch new Work Comp Talk episode 👇

Benefits That Are Not Taxable in 2026

Most injured workers will receive one or more of the following non-taxable benefits:

1. Temporary Disability (TD)

Paid while you are unable to work due to injury.

Calculated at approximately two-thirds of your average weekly wage.

Not considered taxable income.

2. Permanent Disability (PD)

Compensation for lasting physical impairment.

Not based on wages.

Not taxable.

3. Medical Treatment and Future Medical Settlements

Includes:

Surgeries
Physical therapy
Medications
Future medical buyouts

All are considered personal injury compensation and are tax-free.

4. Job Retraining Benefits

Includes:

Supplemental Job Displacement Voucher (up to $6,000)

Return-to-Work Supplement (up to $5,000)

These education and retraining benefits are also not taxable.

When Taxes May Apply

Although most benefits are tax-free, certain situations may create tax liability.

1. Social Security Disability (SSDI/SSI) Offsets

If you receive both workers’ comp and SSDI/SSI:

SSA limits combined benefits to 80% of pre-injury earnings
Excess benefits may be reduced
The offset portion may become taxable

This is one of the most common exceptions.

2. Back Wages (132a Discrimination Claims)

If you win a discrimination or retaliation claim and receive:

Back pay
Lost wages
Employment-related compensation

Those amounts may be taxable, even if included in a settlement.

3. Interest on Delayed Payments

If the insurance company paid interest because of late benefits, that interest is taxable income.

4. Non–Workers’ Comp Income

These remain taxable:

Light-duty wages
Retirement withdrawals
Pension income
401(k) distributions

Workers’ comp does not change the tax treatment of these payments.

Do You Have to Report Your Settlement on Your Tax Return?

In Most Cases: No

You generally do not report workers’ comp benefits as taxable income on:

Federal Form 1040
California state return

You May Need to Report If:

You received taxable back wages
You received interest
You received SSDI offset income
You received a 1099 related to part of the settlement

When in doubt, consult a tax professional.

Important 2026 Update: Bank Deposits and IRS Scrutiny

As discussed in Episode 146, large deposits can raise questions if not properly documented.

If you deposit a settlement check:

Keep settlement agreements
Keep award documents
Keep payment explanations

If the IRS reviews your account, you may need to show that the funds came from non-taxable workers’ comp benefits.

Transparency protects you.

Other Financial Issues That Are Not Taxes (But Still Matter)

Even if your settlement is tax-free, other claims may apply:

Child Support Liens

Workers’ comp settlements may be subject to child support garnishment.

Social Security Credits

Poorly structured settlements may reduce SSDI benefits.

Bankruptcy Disclosure

Workers’ comp is usually exempt, but must be disclosed.

EDD Overlaps

Unreported overlaps with unemployment benefits can create problems.

These issues do not involve taxes directly, but they can significantly reduce your settlement if handled incorrectly.

Key Tax-Saving and Protection Strategies (2026)

1. Structure Settlements Carefully

Proper allocation between:

Medical
Disability
Other components

can reduce future problems with SSDI and taxes.

2. Work With Professionals

Complex cases involving multiple benefits require both legal and tax guidance.

3. Keep Complete Records

Maintain:

Settlement agreements
Payment stubs
Medical allocations
SSDI notices
Interest statements

4. Get Legal Advice Before Settling

Once a settlement is finalized, restructuring is extremely difficult.

Frequently Asked Questions

Are lump-sum settlements taxed?

No, unless they include taxable components such as back wages or interest.

Are penalties and sanctions taxable?

Generally no, unless they represent wage replacement.

Can my employer deduct workers’ comp?

Yes, but this does not affect your taxes.

What if my settlement includes back pay?

That portion may be taxable.

Do I need to report medical settlements?

No, if they are strictly for medical care.

Conclusion

Most workers’ compensation settlements in California remain tax-free in 2026.

However, taxes may apply if your case involves:

SSDI offsets
Back wages
Interest
Employment-related payments

In addition, issues like child support, Social Security, and bankruptcy can affect your settlement even when no taxes are owed.

Understanding these rules before you settle can protect thousands of dollars.

Need Help With Your Case?

If you are unsure how your settlement affects your taxes or benefits, speak with an experienced workers’ compensation attorney.

Pacific Workers helps injured employees structure settlements, protect benefits, and avoid costly mistakes.

📞 Call 800-606-6999 for a free, confidential consultation

🌐 Visit www.pacificworkers.com to get started

About the Author

Bilal Kassem President and Co-founder

Bilal Kassem is the co-founder of Pacific Workers and a nominee for Applicant Attorney of the Year. With a deep-rooted passion for helping injured workers, Bilal leads with empathy and empowers his team to deliver world-class service from the very first interaction.

With extensive experience handling complex workers’ compensation settlements involving tax considerations, Social Security offsets, and financial planning, Bilal has guided thousands of injured workers across California in protecting their benefits and avoiding costly mistakes. His practical, client-centered approach ensures that each case is structured to maximize long-term financial security and compliance.