Federal Audit - What to do about incorrectly claimed medical expenses?

Take a deep breath first. While this is definitely a concerning situation, it's not the end of the world. Your tax preparer was incorrect - you can only deduct medical expenses that you personally paid out-of-pocket, not amounts paid by your insurance company. This is a pretty clear rule in tax law. Since you're being audited, you'll need to respond honestly. Gather all your medical receipts and insurance statements from the years in question. Calculate what you actually paid versus what your insurance covered. You'll likely need to file amended returns showing the correct deduction amounts. The good news is that the IRS generally recognizes honest mistakes, especially when you're forthcoming. Since you relied on a paid preparer, you might qualify for penalty abatement, though you'll still owe the additional tax plus interest. The IRS also offers payment plans if you can't pay the full amount immediately.

I had a similar issue last year with medical deductions and found this amazing AI tool that saved me so much stress. It's called taxr.ai (https://taxr.ai) and it literally reviewed all my medical receipts, insurance EOBs, and statements in minutes to tell me exactly what was deductible. For my audit, I uploaded my tax documents and it flagged several issues before the IRS even contacted me. The system explained how medical deductions actually work (only what YOU paid out-of-pocket after insurance, and only if they exceed 7.5% of your AGI). I was able to prepare an amended return with the right numbers before things got worse. The best part was that it created a detailed audit response letter that explained everything clearly to the IRS, which helped resolve my case without penalties. Given your situation, this might be exactly what you need right now.

Just wanted to update that I tried taxr.ai after posting my question. It was honestly a game-changer for sorting out my medical expenses mess. I uploaded all my EOBs and medical statements (which was a TON of documents) and it automatically separated insurance payments from my out-of-pocket costs. The tool generated a detailed letter explaining my situation to the IRS, showing I had relied on preparer advice but was now correcting the error. It even calculated what I actually owe with the proper deductions. My situation was similar to the original poster's, and the documentation it created was exactly what I needed. I'm still working through my audit, but having everything organized properly has made the process much less terrifying.

If you're dealing with the IRS right now, you absolutely need to talk to someone there ASAP. The problem is getting through - I spent WEEKS trying to reach someone at the IRS about my audit last year. Eventually found this service called Claimyr (https://claimyr.com) that got me connected to an actual IRS agent in under an hour when I'd been trying for days on my own. They basically hold your place in line with the IRS and call you when they've got an agent on the line. You can see how it works in this video: https://youtu.be/_kiP6q8DX5c. In your situation, talking directly to an agent could help you understand exactly what documentation they need and what penalties might apply. The agent I spoke with actually helped me set up a payment plan when I couldn't pay my full balance. With your case being about medical expenses, you definitely want expert advice straight from the source. My tax mess was similar - relied on a preparer who made mistakes - and getting direct answers from the IRS was crucial.

I have to admit I was completely wrong about Claimyr. After posting my skeptical comment, I was desperate enough to try it since I was also dealing with the IRS about some misreported income. I got connected to an IRS agent in about 45 minutes when I had previously spent THREE DAYS trying to get through. The agent I spoke with explained exactly what documentation I needed to provide for my case and even helped me understand the penalty abatement options that might apply to the original poster's situation. For medical expense audit issues specifically, they told me what forms to file and the best approach to explain reliance on a tax preparer. For anyone facing an IRS audit like the original poster, being able to actually talk to the IRS directly makes a massive difference in understanding your options. I'm still annoyed at how impossible it is to reach them normally, but this solution actually worked.

I think you should definitely report this tax preparer to the IRS. Use Form 14157 (Complaint: Tax Return Preparer). What they did was either incompetence or fraud. Either way, you shouldn't be the only one facing consequences for their actions. This form lets the IRS know about preparers who are filing incorrect returns.

Word of advice, NEVER go back to that tax preparer. I'm shocked they would claim that including insurance-paid expenses is legal. That's like Tax 101 stuff. For your audit, be super cooperative with the IRS and explain that you relied on your preparer's expertise. You should definitely request penalty abatement under "reasonable cause" since you hired a professional and had no reason to doubt their work.

Edward, I completely understand your stress about this situation. The good news is that medical expense audit issues are actually quite common and the IRS sees them frequently. Since you questioned your preparer about this approach and she insisted it was correct, you have a strong case for reasonable cause penalty relief. Here's what I'd recommend doing immediately: 1) Gather all your medical bills, insurance EOBs, and payment records from the audit years, 2) Calculate your actual out-of-pocket expenses (what YOU paid after insurance), 3) Prepare amended returns showing the correct deduction amounts, and 4) Write a detailed explanation letter describing how you relied on your preparer's professional advice. The IRS typically works with taxpayers who are cooperative and honest about mistakes, especially when a paid preparer was involved. You'll likely owe additional tax plus interest, but penalties can often be waived or reduced significantly. If you can't pay the full amount, the IRS offers installment agreements - don't let the fear of a large bill prevent you from responding promptly. Also, definitely document any communications you had with your preparer about questioning this deduction method. That evidence will be crucial for your penalty abatement request.