Taxation of Medicaid Waiver Payments
If you are granted a Medicaid waiver, specific IRS tax rules apply to the funds.
Background
The IRS, in 2014, issued Notice 2014-7 specifying that Medicaid waiver wages would be mandatorily excludable from gross income under IRC Sec 131 (qualified foster care payments) if they meet certain requirements. The notice also said this exclusion applied regardless of whether or not the caregiver and the care recipient were related. Payments can be Medicaid waiver payments only if a particular state applied for and was granted a Medicaid waiver.
The Notice went on to say that the exclusion applies to the caregivers of patients who are “placed” in their home or those receiving difficulty of care payments.
This change was a double-edged sword, as some caregivers qualified for the earned income tax credit (EITC) and additional child tax credit (ACTC) based on Medicaid waiver wages. As a result of these payments being mandatorily excluded from income, these caregivers lost their EITC and ACTC based upon that income.
The Feigh Case
Taxpayers, the Feighs, received Medicaid waiver payments as wages for caring for their disabled adult children in their own home. When the Feighs filed their tax return they excluded the income but still treated it as earned income for EITC and refundable child tax credit (much like excludable combat pay is treated). The IRS took umbrage to that position and the case ended up in Tax Court.
The Tax Court held that Notice 2014-7 could not reclassify the taxpayer’s Medicaid waiver payment to remove a statutory tax benefit. Specifically, the Court found that where income does not fall within the plain text of a statutory exclusion from gross income, IRS cannot reclassify that income through a Notice so that it no longer qualifies as "earned income" for the purpose of determining tax credits. The Court reasoned that IRS cannot remove a statutory benefit provided by Congress.
IRS Acquiescence
On March 30, 2020, the IRS issued an Action on Decision (IRB 2020-14). That AOD states the following:
“ The Service will follow the Feigh opinion. Accordingly, in cases in which the Service permits taxpayers, pursuant to the Notice, to treat qualified Medicaid waiver payments as difficulty of care payments excludable under § 131, the Service will not argue that payments that otherwise fall within the definition of earned income under § 32(c)(3) are not earned income for determining eligibility for the EIC and the ACTC merely because they are excludable under the Notice. ”
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What this means is where applicable, returns can be amended to claim EITC or refundable CTC if within the refund statute of limitations.
Completing Form 1040
According to the 2024 Form 1040 and Schedule 1 instructions:
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Nontaxable Medicaid waiver payments should not have been included in W-2 box 1 wages, but should be shown on Form W-2, box 12, coded II. These payments are excluded from taxable income.
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If these payments are taxable but were not included in box 1 of a W-2, enter the amount on Form 1040, line 1d. (This could happen if the issuing agency reported the payments on Form 1099-MISC or 1099-NEC and the care giver is not self-employed.)
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Also enter on line 1d the total of the taxable and nontaxable Medicaid waiver payments that were not reported on Form(s) W-2, or not reported in box 1 of Form(s) W-2, if the taxpayer wants to include nontaxable payments in earned income for purposes of claiming an earned income credit or other tax benefit.
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Enter on Schedule 1 (1040), line 8s, the nontaxable amount of Medicaid waiver payments included on Form 1040, line1a or 1d. Line 8s is preprinted with negative signs, so this amount will be used to reduce taxable income.
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Excluded from income tax, FICA, and SE Tax
Another complication, at least in California, is that back when Notice 2014-7 was issued the California Department of Social Services (CDSS) allowed affected taxpayers to self-certify on Form SOC2298 that they resided in the same home as the individual for whom they were providing the care. Those who self-certified are no longer issued a W-2 for the Medicaid waiver payments. So, another form of income documentation will be needed when filing an amended return. The following is suggested copy to be used when amending a return (use at your own risk).
“ This return is being amended to be in accord with the Tax Court ruling in Feigh v. Commissioner, 152 T.C. No. 15 (2019) T.C. Docket No. 20163-17 and confirmed in IRS acquiescence in an AOD Dated March 30, 2020 (IRB 2020-14). Based on the court case and the AOD excluded Medicare waiver payments are treated as earned income for purposes of computing the taxpayer’s earned income tax credit (EITC) and where applicable, the additional child tax credit (ACTC). In fact, these Medicare payments are earned income regardless of whether the payments are excludable. ”
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