Monies received in a medical malpractice case are tax-free, while awards for wrongful termination or other civil actions are taxable. Legal fees to obtain a personal injury award are not deductible. Legal fees in a workplace action are deductible.
Generally, deductible legal fees can be claimed only as a miscellaneous itemized deduction, which is subject to a 2%-of-adjusted-gross-income floor -- you receive no tax benefit from amounts below the floor. They are not deductible for purposes of the alternative minimum tax.
For awards received after October 22, 2004, legal fees in cases involving wrongful termination due to discrimination can be deducted from gross income as an "above-the-line" deduction. Example: You are awarded $500,000. You pay your attorney 30% ($150,000). The full $500,000 must be reported as income, but you can deduct $150,000, so your taxable income is only $350,000.