When you win a settlement from a lawsuit, the tax on the payout depends on the type of damages. legal settlements from securities litigation is taxed. A legal settlement or court award received is only tax free if on account of physical injury or physical sickness. To determine if the settlement amount you receive must be included in your income, you should consider the item that the settlement replaces.In your situation, the settlement replaces the taxable income / acct. from investment, therefore the settlement amount is taxable. The distribution is supposed to be deposited in your IRA as earnings, then it is non taxable . If you can't get it into the IRA, it counts as a ,probably premature, distribution. Then, it's taxable if it's a traditional IRA. Aslongas you are already in the required distribution mode for your IRA. you could just keep this settlement payment, treat it as a distribution from your IRA, and count it as part of your required minimum annual distribution .