Introduction
On July 4, 2025, the One Big Beautiful Bill Act (“OBBBA”) became law, introducing sweeping tax reforms aimed at simplification and relief for American taxpayers. While many provisions were celebrated, one in particular delivered a blow to plaintiffs receiving taxable legal settlements. The Act permanently eliminated the miscellaneous itemized deduction—a deduction that had already been suspended temporarily under the Tax Cuts and Jobs Act of 2017.
This change, now codified indefinitely, has created a new set of tax burdens for plaintiffs, particularly those in non-personal injury cases, such as defamation, professional malpractice, or breach of contract claims. Without the ability to deduct attorney fees, plaintiffs may find themselves taxed on income they never receive.
This article examines the implications of the OBBBA for plaintiff attorneys and their clients, highlights key exceptions, and outlines tools such as structured settlement annuities and other pre-settlement planning strategies that can mitigate unfair tax results and increase after-tax net settlements.
The Elimination of the Miscellaneous Itemized Deduction
Before 2018, plaintiffs in many taxable settlement cases could deduct attorney fees as miscellaneous itemized deductions. Although the Tax Cuts and Jobs Act of 2017 suspended that deduction through 2025, the OBBBA made the elimination permanent. With this change, plaintiffs can no longer rely on offsetting the tax impact of legal fees through traditional deductions.
This matters because plaintiffs are often responsible for paying taxes on the entire settlement, even on the portion paid directly to their attorney. In effect, the IRS considers gross settlement amounts as fully taxable to the plaintiff, regardless of how much they actually take home. This dynamic creates not only a heavier tax burden, but also, in many cases, a compounding tax injustice —a scenario in which the same dollars are taxed twice.
The Plaintiff Double Tax Trap
This so-called “plaintiff double tax trap” is one of the most financially devastating results of the OBBBA’s reform. In these situations, both the plaintiff and their attorney pay taxes on the same portion of a settlement, once as gross income to the client, and again as earned legal fees to the attorney. It’s a tax outcome that can quietly erode even large settlements unless proactive planning is done before settlement.
Let’s say your client settles a defamation case for $5 million, and you’ve agreed to a 40% contingency fee—$2 million to you, $3 million to the plaintiff.
Under current law, the IRS treats the entire $5 million as taxable income to your client, even though they only actually receive $3 million. You, as counsel, also pay taxes on the $2 million in legal fees.
Now factor in where your client lives. In high-tax states like California, where combined federal and state income tax rates can exceed 50%, the outcome becomes especially alarming. If your client is taxed on the full $5 million, they could owe more than $2.5 million in taxes, even though they only received $3 million. After subtracting the $2 million in attorney fees and $2.5 million in taxes, the plaintiff is left with just $500,000—a mere 10% of the gross settlement.
This is the plaintiff double tax trap in action: the same $2 million in fees is taxed once to you, and again to your client, while leaving them with a fraction of the gross settlement.
Exceptions: When Legal Fees Remain Deductible
While the OBBBA eliminated most itemized deductions for legal fees, certain categories of claims still allow for above-the-line deductions of attorney fees, meaning these amounts can be subtracted directly from gross income, offering crucial tax relief for plaintiffs in qualifying cases.
Employment discrimination claims under federal law, whistleblower cases brought under the False Claims Act or SEC programs, and civil rights actions brought under 42 U.S.C. §1983 all qualify. In these cases, attorney fees may still be excluded from income or deducted above-the-line without being subject to the plaintiff double tax.
The key to preserving above-the-line deductibility of attorney fees lies in properly classifying the nature of the claims in the original complaint (and ideally also in the settlement agreement). The IRS looks first to the complaint to verify which causes of action were alleged, making it essential that qualifying claims—such as employment discrimination, whistleblower actions, or civil rights violations—are clearly identified from the outset.
Personal Injury Settlements: Still Tax-Free (Most of the Time)
For plaintiffs in personal physical injury or sickness cases, the longstanding rule under Section 104(a)(2) of the Internal Revenue Code still applies: compensatory damages for personal, physical injuries (including resulting medical expenses, lost wages, and pain and suffering) are excluded from gross income. These recoveries (thankfully) remain tax-free.
However, not all portions of a personal injury settlement receive this favorable treatment. Two elements in particular trigger taxation even in physical injury cases: punitive damages and judgment-based interest.
Punitive damages, designed to punish rather than compensate, are always taxable and must be reported as “Other Income” on Form 1040, Schedule 1.
Similarly, pre- and post-judgment interest—even in a personal injury case—constitutes taxable interest income and must be reported accordingly. The exclusion under §104(a)(2) does not shield these components, and failing to strategically plan ahead can lead to significant, unwanted tax bills on these portions of a settlement.
Structured Settlement Annuities: Turning Tax Efficiency into Financial Stability
Structured settlement annuities offer plaintiffs a powerful way to manage both the tax impact and long-term use of settlement funds. Instead of receiving a lump sum, the plaintiff elects to receive periodic payments over time, which can be scheduled to align with life events, income needs, or other important life milestones.
In personal injury cases, structured settlement annuities enjoy an added tax subsidy: both the principal and the interest within the annuity are received by the plaintiff entirely tax-free. An annuity in personal injury cases provides guaranteed payments, tax-exempt growth, and protection from dissipation—making it a smart financial move for clients with long-term needs, income replacement needs, or vulnerability to poor financial decision-making.
In taxable cases, structured settlement annuities do not eliminate taxes. However, they offer powerful tax bracket control by spreading income over multiple years. This can lower a plaintiff’s marginal tax rate—for example, from 37% down to 24% or 22%—yielding a guaranteed 13% to 15% savings in addition to the annuity’s own rate of return. Structured settlement annuities allow plaintiffs to invest their gross, pre-tax settlement amount instead of an after-tax lump sum. This lets plaintiffs earn interest on a larger sum of money, enhancing both tax efficiency and long-term security.
Planning Options for Taxable Settlements
For plaintiffs in taxable cases facing a significant tax liability, the most important step is proactive planning before the settlement is finalized. Depending on the facts of the case, there are planning strategies that may reduce the tax impact of the double tax on attorney fees, and the right approach is specific to each situation.
Because these strategies are technical and highly fact-dependent, they should be evaluated with a qualified settlement tax planner rather than applied from a template. Used correctly, they can also work alongside a structured settlement annuity for additional tax planning.
Timing is critical. Most pre-settlement tax planning must be arranged and fully executed before any binding or enforceable settlement agreement is signed. If it is put in place too late, after the terms are finalized, it may be disregarded for tax purposes, and the intended benefit can be lost.
Case Study: Combining Tools for Maximum Tax Efficiency
Consider a plaintiff in a high-profile defamation case who secures a $10 million settlement. Of that amount, $4 million is allocated to attorney fees. Without proper tax planning, the plaintiff is taxed on the full $10 million, despite receiving only $6 million after fees. Depending on state and federal rates, taxes could exceed $4 million, leaving the plaintiff with a fraction of the awarded damages.
Now, consider the same case with proactive tax planning and a structured settlement annuity arranged before the settlement is signed. Spreading the recovery across multiple lower-income years through an annuity can meaningfully reduce the plaintiff's marginal tax rate, and early planning helps ensure the settlement is structured as tax-efficiently as the facts allow. Depending on the case, this combination can leave $1 to $2 million more in after-tax funds than taking the full amount in a single year with no planning.
Engage Settlement Tax Experts Early
Too often, tax planning is treated as an afterthought—something to address after the case is settled. But timing is everything. Many of the most effective planning strategies, including structured settlement annuity-based solutions, require that the strategy be in place before any settlement documents are signed.
Early collaboration with a qualified settlement tax planner ensures that your client’s award is protected from unnecessary taxes. From identifying whether a case qualifies for above-the-line deductions to designing payout schedules that preserve government benefits and lower taxes, a comprehensive settlement planner can align legal, tax, and financial goals into a cohesive plan, freeing attorneys to focus on ensuring the greatest possible result for their clients.
Conclusion: Settlement Without Strategy is a Missed Opportunity
The One Big Beautiful Bill Act permanently eliminated key tax deductions, raising the stakes for plaintiffs and making proactive settlement tax planning essential—not optional. Plaintiffs and their attorneys must now approach settlements with greater foresight and strategy. It’s no longer just about securing the largest verdict or settlement—it’s about ensuring the plaintiff keeps as much of that recovery as possible after taxes are accounted for.
By using strategies like structured settlement annuities and proactive pre-settlement tax planning, and by partnering early with settlement planners, plaintiff attorneys can help their clients walk away not just with a win, but with a well-preserved financial future.
A similar version of this article was originally published in the Utah Trial Journal, Summer 2025 Issue, on July 17, 2025. It is republished here with permission from the publisher and with updates to maintain accuracy.
Author Biographies
Greg Maxwell, Esq., CFP®, advises plaintiff firms across the country on settlement planning, special needs planning, and income tax planning. He founded his plaintiff-loyal settlement planning firm, Amicus Settlement Planners, in 2004. He served as President of the Society of Settlement Planners and is a proud, longstanding annual sponsor of the Utah Association for Justice. Greg can be reached at [email protected].
Bryce Maxwell, CPA, MAcc, is a settlement tax specialist with Amicus Settlement Planners. He helps plaintiffs across the country minimize taxes on legal settlements. His expertise with strategies such as structured settlement annuities and settlement tax planning helps plaintiffs significantly reduce their tax liabilities. Bryce can be reached at [email protected].
