You likely incurred medical expenses in year 1. The settlement payment received in year 2 is compared against year 1 medical expenses as to how much is taxable or repaid against medical expenses previously deducted from income. Year 2 medical expenses are not part of the calculation.
I do not know the nature of your medical class action settlement payment. But I believe that IRS publication 4345 addresses the question that I think is being asked.
“Personal physical injuries or physical sickness
“If you receive a settlement for personal physical injuries or physical sickness and did not take an itemized deduction for medical expenses related to the injury or sickness in prior years, the full amount is non-taxable. Do not include the settlement proceeds in your income.
BUT
“If you receive a settlement for personal physical injuries or physical sickness, you must include in income that portion of the settlement that is for medical expenses you deducted in any prior year(s) to the extent the deduction(s) provided a tax benefit. If part of the proceeds is for medical expenses you paid in more than one year, you must allocate on a pro rata basis the part of the proceeds for medical expenses to each of the years you paid medical expenses. See Recoveries in Publication 525 for details on how to calculate the amount to report. The tax benefit amount should be reported as “Other Income” on line 21 of Form 1040.”
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