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Double Taxation of Personal Injury Plaintiffs

Co-Author – Joe Di Gangi, Director of Financial & Settlement Planning, Settlement Professionals, Inc., and President of Elana Financial. Joe has advised plaintiffs for decades and previously served as President of the Society of Settlement Planners. 

Co-Author – Deborah Hresko, CPA, Koontz & Parkin CPAs. Deborah advises plaintiffs and counsel on a range of tax and accounting issues. She began her career at KPMG.

Plaintiffs lost a key tax deduction in 2018 that many plaintiff lawyers and advisors still haven’t heard about. As part of the Tax Cuts and Jobs Act of 2017, all “miscellaneous itemized deductions” became unavailable through 2025. That includes most deductions of plaintiffs’ legal fees, in addition to everyone’s deductions of financial advisory fees. As a result, a plaintiff pays tax on the legal fee portion of their recovery – then their lawyer does as well. Thus, the fee portion is subject to what many call the “plaintiff double tax.”

When Settlements Are Taxed

In general, settlement proceeds for physical injuries are received tax-free. Most others are taxable, including settlements for wrongful eviction, sexual harassment, and professional malpractice. 

To the surprise of many, nonvisible injuries are often treated as nonphysical injuries. For example, this can include settlements of sexual harassment and post-traumatic stress disorder. Even if a settlement compensates for physical injuries, the portion allocable to interest and punitive damages is taxable. 

Allocation can significantly reduce the taxable portion. When a settlement agreement explicitly allocates proceeds to tax-free purposes, it can (1) shift the burden of proof from the plaintiff to the IRS and (2) avoid the treatment of tax-free proceeds as taxable.

Typically, a defendant can agree to such language without risk of liability. The defendant’s greatest risk is from penalties for failing to file the appropriate IRS 1099-MISC. And in most cases, the facts clearly show that the defendant need not file. 

The Plaintiff Double Tax

When any portion of a settlement is taxable, we also worry about the “plaintiff double tax.” Since 2018 many plaintiffs have been unable to deduct the contingent fee paid to their lawyer. As a result, a $1 million settlement may go to their lawyer (40%), to pay federal and state income tax (40%), leaving only 20% for the plaintiff.

In a narrow set of cases plaintiffs can still deduct their legal fees: unlawful discrimination cases, whistleblower cases, and cases in which the plaintiff is a business. Otherwise, plaintiffs face what many call the “plaintiff double tax.” The plaintiff pays tax not only on the portion they receive, but also on the amount paid to their lawyer.

Best Strategies

Plaintiffs have three good tools to reduce their tax. First, as discussed above, they can use the settlement agreement to reduce taxation of tax-free proceeds. That is, when the facts support it.

Second, plaintiffs can avoid taxation of the legal fee portion of their recovery. This article in Bloomberg Tax described such a trust strategy. It’s effected by the Plaintiff Recovery Trust at Eastern Point Trust Company, which you can read about here. By transferring claims to a split-interest trust, plaintiffs can often double their recovery. The arrangement was designed by Jeremy Babener, an expert in creating legal arrangements and former fellow of the U.S. Office of Tax Policy, and Larry Eisenberg, a benefits tax expert and creator of other tax-saving strategies.

Third, plaintiffs can defer taxation of their recovery through a “structured settlement.” By receiving the recovery over many years, they reduce the tax rate that applies. And, because structured settlements provide a return that is not taxed until payout, the recovery benefits from tax-free build-up like a 401k.

Together, these strategies can eliminate the plaintiff double tax and secure the plaintiff a stable and tax-efficient financial future. There are many tax and settlement strategies for plaintiffs, each highly specific to the claims, fees, and needs of the plaintiff.

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