Article Highlights:

  • Caring for Disabled Family Members
  • Qualified Medicaid Waiver Payments
  • Exclusion Qualifications
  • Mandatory Exclusion
  • Earned Income
  • Earned Income Tax Credit
  • Tax Court Ruling

Many taxpayers prefer to care for ill or disabled family members in their homes as opposed to placing them in nursing homes, but doing this can be expensive, time-consuming, and exhausting. The government also recognizes home care as a means of reducing the government’s costs in terms of caring for individuals who otherwise would be institutionalized (because they require the type of care that is normally provided in a hospital, nursing facility, or intermediate care facility).

To promote home care and reduce the government’s institutional care expenses, Medicaid (through state agencies) pays home caregivers a small amount of compensation, referred to as a Medicaid waiver payment, to care for an individual in the care provider’s home.

Originally the IRS took the position that these payments were taxable income to the caregiver. Back in 2014, the IRS changed its position and announced that, if the care met certain requirements, the compensation would be excludable and treated in the same manner as excludable difficulty-of-care payments under the foster care payments rule. This is the case even when the caregiver and the individual being cared for are related.

The compensation exclusion applies if the following requirements are met:

  • The compensation must be required due to a physical, mental, or emotional handicap with respect to which the State has determined that there is a need for additional compensation.
  • The care must be provided in the care provider’s home. The “provider’s home” may be the care recipient’s home if the care provider resides there and regularly performs the routines of the provider’s private life, such as sharing meals and holidays with family. In contrast a care provider who sleeps at the care recipient’s home several nights a week but on weekends and holidays resides with his or her own family in a separate home would not be providing the care in the care provider’s home and would not qualify to exclude the Medicaid waiver payments received.
  • The payments must be designated as compensation for qualified foster care or difficulty of care.
  • To be excludable, the care payments are limited to a maximum of five individuals aged 19 and older or ten individuals aged 18 and younger.

Since these payments are treated the same as qualified foster care difficulty-of-care payments, and since compensation for qualified foster care payments is mandatorily excluded, Medicaid waiver payments are also mandatorily excluded. That is, the care provider receiving these payments may not choose to include them in income.

When the IRS originally ruled that the compensation was excludable from income that meant it was no longer earned income and thus lower-income caregivers who were previously able to qualify for the earned income tax credit (EITC) based on the compensation would no longer be eligible for EITC.

The EITC is a refundable federal tax credit for lower-income taxpayers with earned income. The amount of credit is based on income and increases based on the number of children that the taxpayer has (qualified children include those under age 19 and full-time students under the age of 24; there is no age limit when the child is permanently and totally disabled).

Lucky for all Medicaid waiver payment recipients, one recipient took the IRS to Tax Court over the earned income issue. The taxpayers in that court case received payments under a state Medicaid waiver program for providing care to their adult disabled children in the family home and excluded the Medicaid waiver payments from income but still treated them as earned income when computing the EITC,  disregarding the IRS’s position that excluded payments were no longer earned income. The IRS subsequently disallowed the credit, and the taxpayers filed a timely Tax Court petition.

The Tax Court held that the IRS could not reclassify the taxpayer’s Medicaid waiver payment to remove a statutory tax benefit provided by Congress. The IRS subsequently conceded to the court ruling so that even though the compensation is excluded from income it still retains it character as earned income and is to be used to determine the EITC if a taxpayer otherwise qualifies.   

As you can see, the impact of the exclusion can be quite different depending upon your circumstances. If you are receiving Medicaid waiver payments and have not yet dealt with the exclusion, please call this office to see how excluding these payments might affect you.