Penalties, Interest and Taxes
Sunday, November 24, 2002 | 1049 | 0 | min read
Are penalties and interest paid on a workers' compensation award taxable?
In California, all payments made pursuant to Division 4 of the Labor Code are deemed "compensation" (Labor Code section 3201,Doerflinger vs. WCAB (1994), 59 ccc 834), including penalties and interest.
The Internal Revenue Service states:
" Amounts you receive as workers' compensation for an occupational sickness or injury are fully exempt from tax if they are paid under a workers' compensation act or a statute in the nature of a workers' compensation act. The exemption also applies to your survivors. The exemption, however, does not apply to retirement plan benefits you receive based on your age, length of service, or prior contributions to the plan, even if you retired because of an occupational sickness or injury."
Thus, since penalties and interest are "compensation" paid under a workers' compensation act in the nature of a workers' compensation act, such are not taxable, not reportable, and any carrier or TPA issuing an IRS Form 1099 may be subject to penalties upon audit under Labor Code section 129.5 (d)(4):
" (d) In addition to the penalty assessment permitted by subdivision (a), the administrative director may assess a civil penalty, not to exceed one hundred thousand dollars ($100,000), upon finding, after hearing, that an employer, insurer, or third-party administrator for an employer has knowingly committed and has performed with a frequency as to indicate a general business practice any of the following:
" (4) Discharged or administered compensation obligations in a manner as to cause injury to the public or those dealing with the employer or insurer. Upon a second or subsequent finding, the administrative director shall refer the matter to the Insurance Commissioner or Director of Industrial Relations and request that a hearing be conducted to determine whether the certificate of authority, certificate of consent to self-insure, or certificate of consent to administer claims of self-insured employer, as the case may be, should be revoked."
The tax consequences of a payment on a penalty may differ from state to state because of the IRS definition above, however in most states, a penalty on a benefit is generally considered to be just a further part of the compensation to which an injured worker is entitled. If in doubt, counsel should first research the general definition of "compensation" within the state's workers' compensation scheme, then consult with a knowledgeable tax specialist.
In addition, if a carrier or TPA is sending your clients an IRS form 1099 for payments made on penalties and interest, that in itself may be a penalty situation or actionable as discrimination and further evaluation of the situation would be warranted.