I'm sorry for the confusion. I hope the following helps.
Regarding the settlement being included in income:
Interest, punitive damages, emotional distress or mental anguish, and employment discrimination or injury to reputation settlements are generally taxable.
• Interest: Amounts on any settlement are taxable as “Interest Income” and should be reported on line 8a of Form 1040.
• Punitive Damages: Amounts are taxable and should be reported as “Other Income” on line 21 of Form 1040. It does not matter if punitive damages are related to a physical injury or physical sickness.
• Emotional distress or mental anguish: Amounts are taxable to the extent that they exceed medical cost, not previously deducted, for treatment of emotional stress of mental anguish. A statement showing the entire settlement amount less related medical costs should be attached to the return. The net taxable amount should be reported as “Other Income” on line 21 of Form 1040.
• Employment discrimination or injury to reputation: Amounts are taxable and should be reported as “Other Income” on line 21 of Form 1040.
(note that if medical care were required, recovery of those expenses would be excluded from income).
Regarding the deductibility of attorney fees, this situation changed recently for discimination cases:
see the following:
Deduction for Discrimination Suit Costs — A new deduction is available for those who pay attorney's fees and court costs in connection with discrimination suits. Taxpayers can take the new deduction whether they itemize or not. The deduction cannot exceed the amount includible in income for the year on account of a judgment or settlement resulting from the discrimination claim. Generally, personal legal expenses are not deductible, but an employee who incurs legal expenses related to doing or keeping his job could deduct these expenses on Schedule A as a miscellaneous itemized deduction. However, under The American Jobs Creation Act of 2004, an individual with legal fees and court costs arising from a discrimination suit may deduct the costs directly from income on the front of the tax
return; this is known as an above-the-line deduction.
Under this new deduction, amounts paid for attorney's fees and court costs are deductible in computing alternative minimum tax
, and are not subject to the 2 percent floor on miscellaneous itemized deductions
or the overall limitation on itemized deductions. The Act, signed into law
on Oct. 22, 2004, describes the discrimination claims qualifying for this new deduction. Only costs paid after Oct. 22, 2004, for judgments or settlements occurring after that date qualify for this deduction.
I hope this information helps and please don't re-accept the question.