Economic damages should return a plaintiff to the position they would have been in “but for” the underlying improper act[s] by the defendant. They should not provide a windfall to plaintiff. In a similar vein, whether such damages are taxable is generally related to how the proceeds would have been treated if obtained in the ordinary course instead of through litigation. This is known as the “origin of the claim” doctrine.
However, there are exceptions to that guidance and differing treatments for the cost of attorneys fees depending on the source of the income. Advice from a tax professional is advisable, especially before structuring allocations to specific claims within a settlement. Additional detail is available is available in this article regarding whether litigation proceeds are taxable.