Attorney's Fees to recoup back wages

[mrh]

In 2004, I received back wages from a lawsuit. The wages were earned in CA and TX. None of it was earned in AZ. We moved to AZ in 1998. Initially, the attorneys fees were deemed non-taxable for federal purposes. However, the federal government appealed and we lost. I filed an amended federal return to include the attorney fees as wages and as a deduction on Sch. A. I did not amend the AZ return, as I thought the wages were non-taxable in AZ. The returns were timely filed and the amended was filed in June 2005. In September 2009, we get a notice of proposed assessment for our 2004 AZ. The IRS had sent a notice to us in 12/06 about the adjustment. I replied to the proposed assessment and advised I was not in agreement. I have sent them information about the lawsuit stating that the money was not earned in AZ and should not be taxed in AZ. Since I used Turbo Tax, part of the income was included in AZ. The only amount left off were the attorney fees. The amount is left off is 5.29% of the total income. From what I read online in the AZ tax code, it appears that AZ follows the IRS code when in comes to income. Am I right in this? Do I need to include the attorney fees as income and then deduct them as Itemized Deductions? Is the interest still running?