I am quoting multiple sources that discuss this topic
1) It depends on your facts and circumstances. If your lawsuit was for “personal physical injuries or physical sickness,” then generally the settlement proceeds are not included in your income. An exception applies when some of the proceeds are paid to reimburse you for medical expenses that you deducted on your tax return. If the proceeds were not for personal injuries, then some of it may be taxable to you.
2)"Physical" is still the pivotal word when it comes to damages for emotional issues. If your pain and suffering is the result of injury or illness that gave rise to your lawsuit, the damages aren’t taxable. If your lawsuit relates to something other than personal injury, such as discrimination, defamation or an employment issue, the IRS will tax you on the money at the percentage rate determined by the tax bracket you fall into when adding in your other income. You’ll also have to pay Social Security and Medicare taxes on the damages. If you’re negotiating a settlement with the party you’ve sued, talk to your lawyer before you sign an agreement if your case involves both physical and nonphysical claims. You’ll want to make sure that if your pain and suffering is related to physical injuries or illness, this is clearly stated.
