In 2008 I received $25,000 from a personal injury accident...?

I put $18,000 into a traditional IRA and just spent the other $7000.00. I did NOT report any of the settlement proceeds in my 2008 AGI nor did I use the IRA deposit to reduce my reportable income. In 2009 I withdrew the $18,000.00 from the IRA, paid tax on the interest but not on the $18,000.00. The bank sent me a 1099 for the $18,000.00 withdrawal but I ignored it since the $18,000, was nontaxable proceeds from the accident settlement. The IRS recently billed be more than $3000.00 for the 2009 withdrawal and a Form 8606 saying to prove I did not owe the additional tax. I did work in 2009 but made only $12,000. I was 60 years old and on SSD in2009 when the $18, 000 was with drawn. There was not other activity on that except except the deposit in 2008 and the withdrawal in 2009. Do I have a tax liability even though the entire contribution was from nontaxable proceeds? If not where on the form 8606 are the critical responses? Thank you ahead of time.|||Generally, taxes are not paid on personal injury settlements unless the settlement is made for punitive or exemplary damages.