My husband and I incurred several different types of expenses and loss of income as a direct result of a wrongful termination lawsuit that took three years before the defendants finally agreed to a settlement. Out of the total settlement amount, the defendants deducted and then paid all of my attorney's fees. Then the defendants paid me the remainder in two separate payments, 10% of the remaining balance was paid to me to compensate me for lost back wages and the other 90% was paid to me for pain and suffering because they had severely and permanently injured my reputation by falsely claiming that I locked an employee in my office and held her captive against her will. (This was a bogus claim and accusation because in actuality, I was giving the employee a written warning for hiding customer checks (payments) in the drawers at her work station for months on end and never depositing these checks into the company's bank account).
We are very sorry for the losses you sustained, but very excited that you won your case.
Some of your settlement is not taxable, that's the good news. The IRS tax law in these situations is based solely on whether you received taxable income as a result, and then you are allowed to deduct expenses only the extent of that taxable income. The taxable amount of your settlement creates the ability for you to deduct expenses that were attributable to obtaining the income that is taxed. This includes your legal fees. However, it does not include the losses you sustained on investments that had to be used to allow you to financially survive while pursuing your argument with the courts.
If there is any exception to the premature distribution of your retirement accounts that can be used, if not, there is no remedy for that additional tax. You can use this link to determine if any exceptions apply:
There is an IRS chart here if you would like to review: Retirement Topics-Exceptions to Tax on Early Distributions
You can report your taxable legal settlement by using the information below. Also use the hyperlink to see what part of the lawsuit settlement is considered tax-free.
https://ttlc.intuit.com/replies/3302162
You can go directly to enter the legal fees using the steps here.
Since personal attorney fees are a miscellaneous itemized deduction, they are limited by the two percent rule: They are deductible only if, and to the extent, they (along with all your other miscellaneous deductions, if any) exceed 2% of your adjusted gross income (AGI). If you are unable to use the itemized deductions because the standard deduction is a greater amount TurboTax will optimize and use the best outcome for you. (Standard deduction chart attached for your review)
Just a note: since the defendants paid my attorney directly, there was no part of the settlement amount that I received was not taxable. Of the amount that I received, 90 % was identified as payment for pain and suffering and I had to pay income taxes on the entire amount of that portion of my settlement. The remaining 10% balance of my portion of the settlement was identified as back wages and the defendants withheld employment taxes on that amount. So, just to reiterate, there was no portion of the amount that the defendants paid me that was not taxable according to the IRS.