Generally, settlements received due to personal injury or
personal sickness are fully excludable from taxable income. Since the income is
not taxable, there can be no tax deduction for medical payments made from the
proceeds of the settlement, as that would result in a double benefit.
Care should be taken with regard to any medical expenses related
to the settlement that you may have paid and deducted from prior years' tax
returns. The portion of your settlement that reimburses you for the tax benefit
resulting from such prior tax deductions would be treated as taxable income in
the year received.
For more details, please see IRS Pub. 4345 Settlements -
Taxability.