Pay taxes on reimbursement I didn't deduct?

I don't think so. It's a reimbursement of expenses, net zero.

I am pretty sure it is taxable if the legal fees were deducted; at least that is what my attorney told me at the settlement.

My question is if I couldn't deduct them because they didn't exceed 2% of my AGI; are they still taxable.

No. See

And be aware, even if the legal fees did exceed 2% of AGI, the deduction is not allowed under AMT, so if you were under AMT you wouldn't have received a benefit from this deduction.

If only part of the fees was deductible because of the 2% rule, then the reimbursement is only partly deductible in my opinion.

I appreciate your help; you may have saved me some serious money!

Lets say I got legal fee reimbursement of $60,000 in 2007 which covered $20,000 paid in 2007 and $40,000 paid in earlier years.

I SHOULD have paid tax on $40,000 because that is all I deducted in earlier years. The remaining $20,000 is not income because it simply offsets the $20,000 in 2007 legal fees that I haven't deducted.

Is that it? I ran the numbers through Taxcut and it says that I get $8,000 back! (because I paid tax on the entire $60,000 and couldn't deduct the $20,000 in legal fees.)

To take this one step further; if I only got to deduct $15,000 of that $40,000 in earlier years because of either AMT or the 2% of AGI rule, than I only have to pay taxes on $15,000 of the reimbursement; right?

That will take a few hours of work to straighten out, but if it saves me another $10,000...

Although I did my tax return first on Taxcut for 2007 to get organized, I had an accountant actually do it for real because it was complicated and I wanted to make sure I didn't have any errors. He missed this.

But I've already spent the money! Your explanation makes more sense, but obviously that isn't a contraint. Thanks.