Injured workers face many challenges. The pain of being injured and the need to recover from the injury are already a lot to deal with. Financial uncertainty is also a factor, as many workers experience the anxiety of not knowing how they'll be able to cover all of their bills without a regular paycheck.
Workers' compensation and Social Security disability benefits are supposed to ease that financial strain. But those benefits don't always stretch as far as an injured worker really needs them to. For that reason, a recent decision by the U.S. Tax Court on whether workers' compensation benefits can be excluded from taxable income is of significant concern.
The case that addressed this issue is Sherar v. Commissioner of Internal Revenue. The U.S. Tax Court decided the case on April 6. The court held that certain workers' compensation benefits were taxable as Social Security benefits under section 86(d)(3) of the tax code.
Facts of Sherar Case
Linda Sherar suffered not one but two work-related injuries in 1998. The injuries occurred only two months apart. She underwent a total of 12 surgeries and started receiving workers' compensation in 1999.
Four years later, in 2003, she applied for Social Security disability benefits. Though Mrs. Sherar's application was initially denied, she was eventually successful on appeal and started receiving Social Security Disability Income (SSDI) in 2007.
On the Social Security Benefit Statement (Form SSA-1099) that Mrs. Sherar received from the Social Security Administration, SSA noted a "workers' compensation offset." But Sherar did not report any Social Security benefits as income.
The Internal Revenue Service asserted, however, that 85 percent of the Social Security benefits Mrs. Sherar received in 2007 should have been included in gross income on the joint tax return she and her husband filed.
The Tax Court's Reasoning
In its written opinion in the Sherar case, the U.S. Tax Court acknowledged that the general rule that "workers' compensation is generally excludable from a taxpayer's gross income."
But the court went on to note that Social Security disability benefits "may be includable in a taxpayer's gross income pursuant to a statutory formula." This formula involves several factors, including:
- Amount received in Social Security benefits
- Other income of the taxpayer
- Filing status
The court further noted that, under section 86(d)(3) of the tax code, the amount of Social Security benefits may include the amount of workers' compensation benefits received."
More specifically, this means that "if the amount of Social Security benefits that a taxpayer receives is reduced because of the receipt of workers' compensation benefits," there will be what is usually called an "offset." With an offset, "the amount of workers' compensation benefits that causes the reduction . . . is treated as though it were a Social Security benefit.
The court recognized that if Mrs. Sherar had not applied for Social Security benefits her workers' compensation would not have been subject to federal tax. The court nonetheless concluded that under the tax code the amount by which her Social Security benefits were reduced by workers' compensation benefits (i.e., the "offset" amount) must be considered to be a Social Security benefit - and is therefore taxable.
Implications of the Decision
Clearly, in light of the Sherar decision, injured workers who are potentially eligible for both workers' compensation and Social Security disability benefits should weigh their decision closely. The fact that the workers' compensation "offset" amount is now held to be a taxable Social Security benefit means those benefits will not stretch as far as they used to for injured workers who receive both types of benefits.
If you have been injured, and this choice applies to you, it makes sense to talk it over with a lawyer experienced in workers' compensation and Social Security disability cases.
Role of Colorado Law
It should be noted that the Sherar decision applies only to federal tax law. Another good reason for seeking legal counsel is to understand the potential impact of Colorado's state tax code.
Colorado is one of only a few states in which, by statute, workers' compensation offsets for one-half of SSDI benefits. For this reason, the tax ruling may not apply to those receiving workers compensation benefits under Colorado law. However, you should talk this over with a skilled Colorado workers' compensation lawyer.