Thursday, March 18, 2021

TurboTax Gets Medical Expense Optimization Wrong

One of my family members often helps her friends file their income taxes with TurboTax.  For a couple she helped (let’s call them the Greens), she entered their medical expenses the way she thought was best.  Then TurboTax offered to “optimize” the medical expenses.  So, she tried it.  The result was that the Greens owed almost $2000 more in taxes.  So much for optimization.

Optimizing medical expenses is surprisingly tricky.  You get to decide which partner in a couple makes the claim.  The Greens have unusually large medical claims this year.  When Mr. Green claims them, the total taxes owing for both of them is nearly $2000 less than when Mrs. Green claims them.  But TurboTax insists that Mrs. Green should claim them.  What went wrong?

The answer begins with how medical expenses affect your taxes.  First, your claim is reduced by 3% of your net income, but this reduction is capped at $2397 (in 2020) for higher earners.  So, if both Mr. and Mrs. Green had high incomes, it wouldn’t matter much who claims the medical expenses, because they would each get the same increase in non-refundable tax credits, and the tax reduction you get from non-refundable tax credits is a fixed percentage.

However, the $2397 cap on the medical expense reduction isn’t relevant to the Greens.  So, their reduction is 3% of the net income of whoever makes the medical claim.  So, it would seem that it’s better for the lower-income partner to make the claim.  This appears to be what TurboTax did because Mrs. Green’s net income is a few thousand less than Mr. Green’s.

The problem is that Mrs. Green wouldn’t owe much tax without the medical claim.  They’re called “non-refundable” tax credits because they can’t cause your total tax owing for the year to go below zero.  So, if Mrs. Green makes the medical claim, she gets more non-refundable tax credits than Mr. Green would get, but this doesn’t help because her taxes only go down very modestly.

It’s better for Mr. Green to make the medical claim in this case.  But the fun doesn’t end there.  It turns out that the medical claim is so large that much of it is wasted by having Mr. Green claim it all.  They could split the claim, but this leads to two separate 3% of net income deductions, and it wouldn’t help Mrs. Green much anyway because she is already paying very little tax.

It turns out the best answer is to have Mr. Green claim just enough of the medical expenses to reduce his taxes owing to zero.  Then they can use the rest of the medical claims next year.  The rule is that you can claim medical expenses for any 12-month period that ends in 2020.  So, Mr. Green should choose an end date that includes just the right amount of medical expenses to eliminate any tax he owes for this year.  Then the Greens can use the remaining medical expenses next year.

All of this is very specific to the Greens’ particular situation.  The important thing is to understand how the rules work to be able to optimize other situations.  Deciding how to claim medical expenses is tricky and, apparently, TurboTax doesn’t help.


  1. It's not correct that a non-refundable tax credit can't cause a tax refund. You can certainly get a tax refund in this case. What a non-refundable tax credit cannot do is reduce your tax below zero.

    1. Anonymous,

      This is just a failed nitpick. If you get a refund, it will be because of something other than your non-refundable tax credits, such as having paid taxes through the year or some refundable tax credit.

    2. You really need to change the line that non-refundable tax credits can't cause a tax refund. That is just flat out wrong.

      The majority of us pay taxes through the year through withholdings or quarterly installments. To say that a non-refundable tax credit such as a medical expense will not lead to a refund is a complete misunderstanding of what non-refundable tax credits are. What they cannot do is reduce your total tax payable for the year below zero. Only refundable tax credits can do that.

    3. Anonymous,

      In the scenario you describe, the cause of the refund is the overpayment of taxes through the year, not the non-refundable tax credits.

    4. Despite the tone of your comments, I've decided that the change you suggest would help most readers who would not get the subtlety of what causes a return of some of the taxes they paid through the year.

    5. Thanks for making the change. Subtlety is not one of my gifts. Sorry if I caused offense.

    6. However, we got here, the change makes the article clearer, which is good, but it's still open to criticism. Consider the following case. By early December, George had a mix of refundable and non-refundable tax credits to go with his employment income. He was on track to have total taxes owing for the year above zero. Then, some event caused him to get a large new non-refundable tax credit before the end of December. Suddenly, his total tax owing for the year becomes negative. George takes the pragmatic view that the cause of his negative tax total is this unexpected event. He then reads that non-refundable tax credits can't cause your total tax owing for the year to go negative. He thinks this is nonsense and that you and I completely misunderstand how non-refundable tax credits work.

      The difference between George and us isn't about not understanding tax rules. The difference is that we think of the refundable tax credits as being the primary cause of George's total tax for the year going negative, whereas he thinks the primary cause was the unexpected event that gave him a pile of new non-refundable tax credits.

      The only way to resolve such differences of points of view is to delve ever further into all the subtleties of income tax calculations. But doing so would be a huge distraction from a simple article about how to declare medical expenses.

      So, while I think the change to the article is a positive one, it's still not immune to criticism.

    7. I agree that the "Medical Expense Optimizer" is hugely confusing.

      Putting aside your completely valid point about choosing an appropriate 12 month period to claim medical expenses (which TurboTax cannot do because it does not know the following years income), there is the misleading optimizer solution even within the calendar year calculation.

      The "Optimizer" requires you to switch back and forth between partners to see who should claim the medical expenses. It then requires you to make a choice without making the correct choice obvious.

      It's highly confusing for the average tax payer.

    8. Anonymous,

      I agree that their optimizer is confusing. However, it appears to make a bad choice even when you figure out how to use it as intended.

  2. It would be interesting to see if Simpletax would optimize differently...

    1. Hi Garth,

      I haven't tried any other tax software to see if it does any better. This is a tricky thing to optimize properly, especially when it can depend on next year's incomes and medical bills. But you'd think that TurboTax would hesitate when the total tax owing rises after its "optimization."