.svg)
10 Things You Should Know About Plaintiff Recovery Taxation
Winning the case doesn’t always mean maximizing the recovery.
The taxation of plaintiff litigation recoveries is widely misunderstood — and the stakes are significant. Here are 10 things every plaintiff and litigation professional should know.
Personal injury lawsuit recoveries are not always tax-free.
Compensatory and emotional distress damages related to physical injuries are generally excluded from income — but punitive damages and interest are not. The nature and origin of the claim, not the label in the complaint or settlement agreement, controls the tax treatment.
Many types of litigation recoveries are taxable, even if there is an injury.
Recoveries for non-physical injuries and related emotional distress, mental anguish, defamation, breach of contract, malpractice, fraud, securities law violations, intellectual property disputes, and many other claims are generally includible in gross income.
Many plaintiffs with taxable recoveries cannot deduct their legal fees.
Personal attorney fees that were once deductible as “miscellaneous itemized deductions” are no longer deductible. IRC §67(g). The One Big Beautiful Bill Act, Pub. L. No. 119-21 (2025), made this suspension permanent. There are limited exceptions — notably, certain employment discrimination and whistleblower cases — but these cover a narrow range of claims. For more details, review this article on settlement and litigation taxation.
The U.S. Supreme Court ruled that plaintiffs are taxed on the attorney-fee portion of their recovery — even though they never receive it.
In Commissioner v. Banks, 543 U.S. 426 (2005), the Supreme Court held that a plaintiff “receives for tax purposes” the attorney-fee portion of a taxable recovery. The consequence: in cases where the attorney fee is not deductible, both the plaintiff and the attorney pay tax on the same dollars. This is referred to as the “attorney-fee double tax.”
In attorney fee double tax situations, plaintiffs in high-tax jurisdictions can end up with little or nothing.
A plaintiff might keep 10% after paying 40% to their lawyer and 50% in Federal, State and Local taxes. And if their attorney had significant expenses not covered by the contingent fee, the plaintiff may end up with close to nothing. In fact, in attorney fee double tax situations, both the government and the lawyers each end up with more than the plaintiff.
You must address taxes before settlement.
Tax planning to reduce taxes on a recovery is only possible while the case outcome is still “contingent and doubtful.” This means the parties have not yet agreed to any binding settlement terms (e.g., verbally, by email, or a binding mediation term sheet). Careful planning is required as early in the process as possible (see Point 10 below). Once the claim resolves, practically speaking it’s too late.
Defendants face significant penalties if they fail to issue a Form 1099 for the gross settlement amount.
In taxable cases, defendants must report the full recovery — including the portion paid to counsel — to both the plaintiff and the IRS. The penalty for failure to report properly can reach 10% of the unreported amount, without limit. Treas. Reg. §1.6041-1(f); IRC §§6721(e), 6722(e). Assuming a taxable recovery will escape IRS scrutiny is not a realistic strategy.
Plaintiff attorneys have an ethical responsibility to consider client tax issues.
ABA Ethical Guidelines for Settlement Negotiations (August 2002) advise that “competent representation” of plaintiffs requires “considering tax implications of the settlement.” Ethics rules require attorneys to inform clients about the consequences of failing to address taxes or obtain competent tax advice.
Many suggested “workarounds” for the attorney fee double tax don’t work.
Strategies sometimes proposed — such as reporting only the net amount received, treating the attorney-client relationship as a partnership, or excluding structured attorney fees — do not survive IRS scrutiny. These approaches also expose plaintiffs to substantial penalties and interest.
Plaintiffs with taxable recoveries can increase their after-tax recovery — if they act before final resolution of the claim.
One approach is to structure the complaint or settlement agreement with the tax character of the claim in mind, to the extent the underlying facts allow. Another is to transfer the litigation claim into a Plaintiff Recovery Trust (PRT) before settlement. The PRT uses an established charitable trust structure adapted for the litigation context, removing the attorney-fee portion from the plaintiff’s taxable income — so only the amount the plaintiff actually receives is taxed.
See How the Plaintiff Recovery Trust May Reduce the Tax on Your Recovery
Every case is different. Our team is available to review potential planning opportunities — at no obligation — before a recovery becomes definite.
Or contact us at recoverytrust@easternpointservices.com
Disclosures
Eastern Point Trust Company offers a variety of escrow services, ministerial services, trust administration services, self-help support software; some of which offer companion self-service and automated software solutions. Fiduciary, escrow, ministerial, and trustee services are only offered and performed by Eastern Point Trust Company in such jurisdictions in which Eastern Point Trust Company is licensed to provide such services and then pursuant solely to the terms of the associated governing documents. Eastern Point Trust Company may act in a ministerial non-fiduciary capacity as escrow agent when applicable. As required by federal law related to “domestic trusts,” fiduciary, escrow, and ministerial services related to “substantial decisions” shall be required to be independently performed by one or more co-trustees or affiliated or non-affiliated parties who are “United States persons.” Fees charged are solely for ministerial services, trustee services, or licensing fees to access the self-help system, and fees are not drafting or document preparation fees. The content herein is provided as-is, and is limited to information and descriptions of the features and benefits of Eastern Point Trust Company’s services, products, and requirements when applicable. This document is for informational purposes only and is not an offer to sell, an offer to buy, or a solicitation for any security. The content herein is not an offer to provide legal, fiduciary, escrow, ministerial, or trust services. The information herein is not intended to be legal or investment advice and should not be construed as legal or investment advice. Eastern Point Trust Company and its affiliated parties are not law firms, are not a lawyer referral service, and do not act as your attorney or investment advisor. Eastern Point Trust Company is not a substitute for the advice of an attorney or an investment advisor. As such, Eastern Point Trust Company does not provide any advice, explanation, opinion, or recommendation about possible legal rights, express any legal guidance on the matters contained herein, nor provide investment advice or management. As appropriate, seek the advice of an attorney if you have questions concerning legal questions, remedies, defenses, or options; seek the advice of a licensed investment advisor related to trust holding(s) or investments. Eastern Point Trust Company and its affiliated companies are not broker-dealers and only forward your instructions to executing custodians/broker-dealers. Your accessing and utilizing this document constitutes your agreement to the Terms and Conditions (a.k.a. Terms of Use) and Privacy Policy shown herein. Please review the Terms and Conditions (a.k.a. Terms of Use) and Privacy Policy carefully, as they contain important information and disclosures and are legally binding. The terms of the applicable agreement, and the Terms and Conditions (a.k.a. Terms of Use) and Privacy Policy on the website shall supersede and have precedent over any information provided for herein. You are solely responsible for protecting the privacy and security of your electronic communications (sent or received). Additionally, it is your duty to secure your systems, networks, devices, browsers, and communications systems and devices with anti-virus and malware protection and anti-breach security software. Any loss resulting from a breach of your systems, networks, devices, browsers, or communications systems and devices is solely your liability.
Educational Disclosure. This material is provided by Eastern Point Trust Company solely as educational content. It is not legal, investment, or tax advice. Always seek the advice of competent legal, investment, or tax advisors to review your specific facts and circumstances.
Any opinions, views, findings, conclusions, or recommendations expressed in the content contained herein are those of the author(s) and do not necessarily reflect the views of the Eastern Point Trust Company, its Affiliates, Third Parties, or clients. The mere appearance of content herein does not constitute an endorsement by Eastern Point Trust Company (“EPTC”), its Affiliates, Third Parties, or clients. The underlying author’s opinions are based upon information they consider reliable, but neither EPTC nor its Affiliates nor its Third Parties nor the company with which such author(s) are affiliated warrant completeness, accuracy, or disclosure of opposing interpretations.
EPTC and its Affiliates disclaim all liability to any party for any direct, indirect, implied, special, incidental, or other consequential damages arising directly or indirectly from any use or reliance on the content herein, which is expressly provided as is, without warranties. Finally, these educational materials are provided as-is. All warranties, express or implied, including but not limited to warranties of merchantability or fitness for a particular purpose, are expressly disclaimed.
Third-party logos and trademarks shown herein are for nominative fair use purposes only and solely for identification or reference. This site is neither endorsed by, sponsored by, nor affiliated with the respective entities. The logos are registered trademarks of their respective companies.
PRT.tax is administered by Eastern Point Trust Company.
For a comprehensive overview of tax minimization strategies, see our guide on minimizing tax liability on lawsuit settlements.
Learn how the Plaintiff Recovery Trust addresses the attorney fee double tax created by Commissioner v. Banks.
You Have Needs,
We Have Expertise
Discover trust and settlement solutions you won’t find anywhere else – thoughtfully designed to protect assets, simplify processes, and deliver peace of mind.
Expert guidance, every step of the way.