My sister received a $65000 settlement for a lawsuit in which the insurance company of a doctor settled with her. Out of this $26000 was deducted for Attorney fees and approx. $12000 for medical expenses paid by the attorney on my sisters behalf. What are the tax implications? What is deductible and what is income?

What is the breakup of $65,000 settlement you received? Normally Settlement for injury is not taxable. If it is for lost wages or interest, it is taxable. Also attorney fees can be deducted from the income.

Agreed. If the settlement is COMPENSATORY in nature (compensating for pain and suffering and used to pay medical costs), then it is NOT taxable at all.

If there are PUNITIVE damages, then the PUNITIVE part will be taxable.

If there IS a taxable part, you CANNOT deduct the attorney's fees directly; they have to be deducted as a miscellaneous deduction on Schedule A.