If you pay a legal settlement as part of doing business, the settlement is a deductible business expense, except that you can't deduct anything related to illegal conduct. (Not all business disputes involve illegal conduct, of course.)
If you pay more than $600, you need to collect their tax number with a W-9 form, and issue a 1099-MISC (unless they check the box on the W-9 that they are an S- or C-corp, in which case you don't issue a 1099-MISC.). If the payment is compensation for services performed by a subcontractor, you would issue a 1099-NEC. If the plaintiff was an employee and the settlement is partly or all for lost wages, you would issue a W-2 as if it was regular wages and you are responsible for withholding the employer's share of social security and medicare like any other W-2.
Once you issue the correct tax report (1099 or W-2), whether the money is actually taxable to them depends on their circumstances and is between them and the IRS.
