IRC 6662 establishes a 20% penalty for "Any substantial understatement of income tax." Issues related to taxation of punitive damages will make it advisable for plaintiff's attorneys, in some instances, to refer their client to tax counsel.
A 2015 Ninth Circuit Court of Appeals case DJB Holding Corp. v. Commissioner is instructive in that it sets forth standards of review and discusses penalties under IRC 6662 based on substantial underpayment, and circumstances for applying the exception under IRC 6664(c)(1) regarding whether the taxpayer had reasonable cause for his or her position and acted in good faith.
Release 65 of "Structured Settlements and Periodic Payment Judgments" (S2P2J) available in mid-April and sent automatically to online subscribers, discusses IRC 6662 in greater detail.
Check out Section 2.03 of the book for additional practice tips for minimizing the risk of an IRS settlement challenge.