Damages 'on account of' personal physical injury or physical sickness are 100% excluded from gross income.
IRC §104(a)(2) excludes from income all damages (other than punitive) received on account of personal physical injuries or physical sickness. Includes compensatory, pain & suffering, emotional distress ORIGINATING from physical injury, and lost wages tied to the injury. NOT excluded: punitive damages, emotional distress without physical origin, interest, employment discrimination without physical injury. Settlement agreement wording is CRITICAL — allocation between excludable and taxable components should be explicit and supportable.
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Structured PI settlement pays tax-free installments for life via a qualified assignment — better than lump-sum + investing.
Depositing settlement into a §468B QSF lets plaintiffs delay constructive receipt while negotiating allocations and structures.
Plaintiff attorneys can structure their contingent fee via §130 QAssignment — deferring tax to payment years.
For taxable settlements, use a Plaintiff Recovery Trust or origin-of-claim allocation to avoid attorney fees being taxed to plaintiff.
If emotional distress ORIGINATES from a physical injury, entire settlement is tax-free — even the emotional portion.
IRC §62(a)(21) allows above-line deduction for attorney fees on federal whistleblower recoveries — full net-of-fees tax.
MSA earmarks portion of PI settlement for future Medicare-covered care so plaintiff doesn't lose future Medicare eligibility.
Forced to repay income taxed in a prior year? §1341 lets you deduct now OR recompute prior year — take the bigger benefit.