Sick pay received from an employer is generally taxable as wages unless it qualifies as workers’ compensation. An exception applies for payments received under accident or health plans; they are generally tax-free. Sick pay is subject to income tax withholding as if it were wages, unless it is from a third party (such as an insurance company).
You do not pay tax on workers’ compensation payments for injuries or illnesses suffered on the job. However, some employers may continue to pay your regular salary but require workers’ compensation payments be returned to them. If that is the case then you are taxed on the difference between what was paid and what was returned. For example, if you receive $250 a week from the state for workers’ compensation but your employer continues to pay a weekly salary of $1,000 then $750 ($1,000 minus $250) is considered taxable income.
To qualify as tax-free workers’ compensation, the payments must be made under the authority of a law that provides compensation for on-the-job injury or illness. Payments made under a labor agreement do not qualify as tax-free workers’ compensation. A retirement pension or annuity also does not qualify for tax-free treatment if the benefits are based on age, length of service, or prior plan contributions when retirement was triggered by a work-related injury or sickness.