The 2025 Tax Law permanently eliminated personal exemptions. As a result, individuals can no longer deduct attorney fees and expenses from their taxable litigation settlements—they must now pay taxes on the gross recovery.
Congress carved out exceptions only for pure employment and civil rights settlements.
Key Tax Implications
- Personal Injury Cases: Attorneys rarely deal with tax issues because compensation for personal physical injuries is exempt under Section 104(a)(2).
- Non-Physical or Punitive Damages: Taxable damages from non-physical injuries or punitive awards are generally addressed after a settlement is reached but before funds are distributed.
The Role of a Plaintiff Recovery Trust (PRT)
The only meaningful remedy appears to be the Plaintiff Recovery Trust (PRT), which must be established before mediation and prior to a settlement agreement.
- Litigation is transferred into the trust before settlement.
- The trust can legitimately deduct attorney fees and expenses.
- The trust distributes funds to the plaintiff, issuing a K-1 tax form.
Example: Wrongful Death Case in Texas
(Gross Negligence Under §408.00(1)(2))
| Without PRT | With PRT | |
|---|---|---|
| Settlement | $1,000,000 | $1,000,000 |
| Attorney Fees (40%) | — | $400,000 |
| Taxable Income | $1,000,000 | $600,000 |
| Tax (35% bracket, no other income) | $350,000 | $210,000 |
Key Outcomes:
- Difference to client: $140,000 more (a 66.7% improvement).
- Case expenses are deductible through the PRT.
- If the survivor claimant is a minor, the Kiddie Tax applies.
- Additional savings can occur by structuring proceeds over several years (e.g., spreading $600,000 across four years lowers the bracket to 22%).
Why a PRT Is Essential
Without a PRT, attorney fees can exceed the client’s net recovery—a malpractice trap waiting to happen.
- Attorneys risk being unable to justify fees that leave clients worse off.
- Proper planning is critical: establish the PRT before mediation.
- There are no upfront costs, but failing to act creates significant problems.
- Settlement finalization can be deferred until the PRT is in place (extensions may be allowed if court orders or appeals are involved).
Special Considerations
- Appeals: Interest accumulations of $100,000 or more should be factored in. Punitive damages must always be considered.
- Trial Verdicts: A PRT remains viable if:
- No binding release has been signed (or agreement to sign one).
- A technical risk exists that the award could be overturned on appeal.
Bottom Line
Plaintiff attorneys must treat these cases with extra care and foresight. A Plaintiff Recovery Trust can mean the difference between malpractice risk and protecting your client’s financial future.