IRS Regulations
According to the IRS, any lawsuit settlement proceeds that a court awards for physical illness or injury are non-taxable. This includes wrongful death settlements, since the damages are imposed due to a court’s finding that a third party is responsible for the physical illness or injury that resulted in death. To qualify for this exception, the settlement must be compensatory, meaning that it must be a form of compensation for the pain and suffering caused in the case.
Since compensatory proceeds are non-taxable, they have no impact on a federal tax return. However, if there are any additional proceeds that are awarded such as punitive damages, payments for emotional distress, or awards for lost wages, those payments are considered income and are subject to income tax. Punitive damages are additional financial awards that a court may give to the family of a deceased or injured person in cases where the company or individual responsible for the death showed gross neglect or disregard.
https://ttlc.intuit.com/replies/7449321
From Opus 17:
Generally speaking, payments for personal injury or property damage are not taxable, but recoveries for punitive damages or lost wages/income are taxable.
There are a number of variations (like, if you deducted medical expenses in a prior year that are now paid off by the settlement, you have a report a reimbursement of a deduction, and that is taxable. Or, if you received money for your damaged car and the money is more than the car was worth, the excess is taxable). This link provided gives more examples. http://www.irs.gov/pub/irs-pdf/p4345.pdf
Your attorney costs are deductible, but only as far as the damages are taxable (if 50% of your damages are taxable, then 50% of your fees are deductible). And they are a miscellaneous deduction subject to the 2% rule, so you may or may not actually benefit from claiming the deduction.
In a perfect world, you would receive a 1099-Misc from the payer that only lists the taxable part (wages and such).
https://ttlc.intuit.com/questions/1901380-entering-an-award-from-a-legal-settlement-in-turbotax
