What Caregivers Need to Know About Medicaid Waiver Payments
Medicaid waiver payments can create unusual tax issues because they sit at the intersection of health care, social services, and the tax code. For many caregivers, these payments are not just compensation for providing daily care; they can also affect eligibility for the Earned Income Tax Credit (EITC) and the Additional Child Tax Credit (ACTC). The key is understanding what the payments are, who can receive them, when they are excluded from income, and when they may still be counted as earned income for tax credits. IRS guidance and later court decisions have shaped how these payments are treated, and taxpayers need to be careful when reporting them.
What Are Medicaid Waiver Payments? Medicaid waiver payments are made under a state Medicaid waiver program that allows individuals to receive care in a home or community setting instead of an institution. In practical terms, these payments are often made to family members or other caregivers who provide “difficulty of care” services for a person who needs assistance with daily living. The payments are tied to a state-approved waiver program, not simply any informal family caregiving arrangement.
These programs were created for a reason: to reduce reliance on institutional care and allow people with disabilities or chronic needs to remain in a familiar home environment. For the caregiver, the payment helps offset the cost and time involved in delivering care that would otherwise have to be provided by a facility or outside provider. From a policy standpoint, the payments support independent living and home-based care.
From a broader policy perspective, Medicaid waiver programs can reduce costs to the public system while improving quality of life for the person receiving care. They also make it more feasible for family members to provide needed services without bearing the full financial burden themselves.
Who Qualifies for Medicaid Waiver Payments? Qualification depends on the state waiver program and the circumstances of the care. Generally, the caregiver must be providing services under a Medicaid waiver arrangement that the state has approved. A key tax-related point is that, for the payments to receive favorable exclusion treatment, the care provider and the care recipient must reside in the same home, which may be either that of the care provider or care recipient. If they do not live together in the same home, the payments are not excludable under the special rule described in IRS guidance.
That home-sharing requirement is critical. If the caregiver and recipient live together, the payment may fall under the special exclusion for qualified Medicaid waiver payments. If they do not, the payments are fully taxable. That distinction is often where reporting problems begin, especially when family members assume all waiver payments are automatically nontaxable.
Taxability: When Are Medicaid Waiver Payments Excluded? IRS Notice 2014-7 states that qualified Medicaid waiver payments may be excluded from gross income when they meet the required conditions, including the same-home rule. That means qualifying payments are not reported as taxable income for federal income tax purposes.
However, the exclusion is not automatic in every situation. If the care provider and care recipient do not live in the same home, the payments are not qualified Medicaid waiver payments for this special exclusion and are fully taxable to the care provider. That makes residency and program structure essential facts for tax preparation.
Even where the payments are excluded from gross income, there is an important additional issue: the tax law may still allow the payments to be counted as earned income for certain credits. That is where the EITC and ACTC come into play.
Reporting Issues: Why These Payments Can Be Confusing. One of the most common reporting issues is that a taxpayer may receive a Form W-2 showing Medicaid waiver payments in Box 12 with code II. That code identifies payments excluded from income under IRS Notice 2014-7. The presence of that code does not necessarily mean the amount must be ignored for every tax purpose; it means the payments were treated as excludable from gross income. The individual may still be able count that income as earned income for purposes of the EITC and the ACTC benefits.
Another complication is that some taxpayers, especially in states with self-certification systems, may not receive a W-2 at all once the program moves to a different administrative process. In those cases, the taxpayer may need other records to substantiate the amount received when preparing a return or amending a prior-year return. Accurate documentation matters, particularly if the taxpayer later seeks to claim a credit based on the payments.
Excluded Medicaid Waiver Payments Still Count as Earned Income: Originally the IRS took the position that the excluded income did not count as earned income which is needed to qualify for the Earned Income Tax Credit (EITC) and the Additional Child Tax Credit (ACTC). A major turning point came in the Tax Court case involving Mary and Edward Feigh. The taxpayers received Medicaid waiver payments for caring for their disabled adult children in their home. They excluded the payments from gross income but still treated them as earned income for EITC and ACTC purposes. The IRS disagreed, and the case went to Tax Court. The Feighs prevailed in court and the IRS subsequently acquiesced, and thanks to the Feighs, the Medicaid waiver payments can now be treated as earned income for purposes of the EITC and ACTC.
The IRS instructions also recognize a separate election rule when both spouses receive Medicaid waiver payments. If a married couple files a joint return and both spouses received qualified Medicaid waiver payments, each spouse can make a separate choice about whether to include those amounts in earned income. That flexibility can affect the size of the EITC calculation.
Can Prior Returns Be Amended? If the year is still open under the refund statute of limitations, past returns may be amended for a refund. The general statute of limitations for federal tax refunds is three years from the original filing deadline (or the date the return was filed, whichever is later) or two years from the date the tax was paid, whichever is later
Taxpayers who previously excluded qualified Medicaid waiver payments from income may be able to amend a return to include those payments in earned income for EITC and ACTC purposes. This can generate a refund if the credit was previously underclaimed or denied because the income was not counted.
This is particularly important for taxpayers who filed before the IRS’s post-Feigh position was clarified or before they understood that the exclusion from gross income and the earned-income treatment for credits are separate questions. For some households, the difference can be several hundred or even several thousand dollars.
Key Takeaways
Medicaid waiver payments are designed to compensate caregivers who provide home-based care under a state-approved waiver program. When the care provider and care recipient live in the same home, the payments may be excluded from gross income under IRS guidance. When they do not live together, the payments are taxable.
For EITC purposes, the most important rule is that qualified Medicaid waiver payments may still be counted as earned income even when they are excluded from income. The Tax Court in Feigh, and the IRS’s later acquiescence, confirmed that the IRS cannot deny this earned-income treatment merely because the payments are excluded under Notice 2014-7.
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