Punitive damages are ALWAYS taxable — plan for timing, install-payment, and entity ownership to soften the blow.
Punitive damages and pre-judgment interest are ordinary income (NEVER §104(a)(2) excluded). Strategies: (1) two-check settlement — separate check for punitives clearly labeled, so compensatory can be reinvested tax-free while punitives are the only taxable event, (2) installment agreement to spread income over multiple years, (3) route punitive award to LLC/S-corp with high current-year losses (NOL absorption), (4) charitable pledge in same year (bunched DAF), (5) if plaintiff attorney, structure own fee separately (see attorney fee strategy).
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Damages 'on account of' personal physical injury or physical sickness are 100% excluded from gross income.
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.