And they are correct. If you reported the loss on your otherwise taxable inherited stock, then you have to report the income. The general rule of taxability for amounts received from settlement of lawsuits and other legal remedies is Internal Revenue Code (IRC) Section 61 that states all income is taxable from whatever source derived, unless exempted by another section of the code.
The basis of the stock is not the value of the stock when transferred to Fidelity. I don't know what the broker used but your basis for the inherited stocks is the value of the stock on the date of death.
The settlement should be shown as on the Form 1099MISC you received. Settlement money and damages collected from a lawsuit are considered income, which means the IRS will generally tax that money, although personal injury settlements are an exception (most notably: car accident lawsuits and slip and fall claims are nontaxable).
Please see the link below for additional Information from IRS>
Tax Implications of Settlements and Judgements etc.
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