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”.
What this means is where applicable, returns can be amended to claim EITC or refundable CTC if within the refund statute of limitations.
TAS Reporting Tip - A Taxpayer Advocate Service Tax Tip explains how to report qualified non-taxable Medicaid waiver payments (MWPs) as earned income for earned income tax credit (EITC) and additional child tax credit (ACTC) purposes on a tax return, even though MWPs are not taxable income. (We have updated the directions to account for the 2021 version of Schedule 1.)
TAS says that on line 1 of the tax return (wages) include MWP received as wages that the taxpayer chooses to include in earned income for purposes of claiming the EITC or the ACTC, even if a Form W-2 was not received reporting these payments.
Then, on Schedule 1, line 8z for 2021, (other income) subtract the nontaxable amount of the MWP from any other income reported on line 8 and enter the result. If the result is less than zero, enter it in parentheses.
TAS notes that for an electronically filed return, enter "Notice 2014-7" as an explanation for the MWP amount reported on Schedule 1, line 8z. For a paper return, write “Notice 2014-7” on the description line for Schedule 1, line 8z.
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.