The difficulty of care payments tax exclusion lets caregivers who live with the person they care for leave that compensation off their federal taxable income under Internal Revenue Code Section 131. Since IRS Notice 2014-7, the exclusion also covers payments made through state Medicaid Home and Community-Based Services waiver programs, so most family caregivers paid through a 1915(c) waiver can treat every dollar as tax-free at the federal level.1Internal Revenue Service. IRS Notice 2014-7 – Difficulty of Care Payments Tax Exclusion
Who Qualifies
Two conditions decide eligibility, and both have to hold.
First, the care has to happen in your home. You and the care recipient must share the same primary residence. Payments for care given at a separate facility, or at the recipient’s home when you live somewhere else, do not qualify.1Internal Revenue Service. IRS Notice 2014-7 – Difficulty of Care Payments Tax Exclusion The IRS has not issued published guidance on edge cases like detached guest houses or accessory dwelling units, so unusual living setups deserve documentation and, if the answer isn’t obvious, professional advice.
Second, Section 131 caps how many people you can claim the exclusion for: up to ten individuals under age 19, and up to five individuals age 19 or older. Payments for anyone beyond those limits are taxable.2Office of the Law Revision Counsel. 26 USC 131 – Certain Foster Care Payments Most family caregivers are well under these caps; foster homes with a larger roster should track headcount by age.
The Medicaid Waiver Requirement
For non-foster caregivers, the funding source is what unlocks the exclusion. The payments must come through a state Medicaid waiver authorized under Section 1915(c) of the Social Security Act.3Internal Revenue Service. Certain Medicaid Waiver Payments May Be Excludable from Income It doesn’t matter whether you’re related to the recipient. Payments funded by private insurance or by state programs that aren’t 1915(c) waivers generally don’t qualify. If you’re not sure which category your program falls into, ask the state Medicaid agency or the fiscal intermediary that cuts your checks.
How to Report the Exclusion on Your Return
How you report depends on the paperwork you receive.
Many agencies now report nontaxable Medicaid waiver payments in Box 12 of Form W-2 using Code II, and leave Box 1 wages at zero. If Box 1 is blank or zero and you aren’t electing to count the payments as earned income for tax credits (see below), you don’t need to enter the W-2 on your return at all.3Internal Revenue Service. Certain Medicaid Waiver Payments May Be Excludable from Income
If your W-2 still shows the payments in Box 1, or if you get a Form 1099-NEC treating them as nonemployee compensation, report the income and then back it out. Put the Box 1 amount on Form 1040, line 1a, and any Box 12 Code II amount on line 1d. Then on Schedule 1 (Form 1040), line 8s, enter the nontaxable total as a negative number inside the preprinted parentheses. That negative figure reduces adjusted gross income.3Internal Revenue Service. Certain Medicaid Waiver Payments May Be Excludable from Income Most tax software does this automatically once you flag the income as Medicaid waiver pay.
Stopping Withholding Going Forward
If your agency is still withholding federal income tax from your checks, you can stop it prospectively with a signed statement. The IRS lets agencies rely on a caregiver’s self-certification rather than verifying the living arrangement themselves. The statement has to be signed under penalties of perjury and identify the care recipient who lives in your home.3Internal Revenue Service. Certain Medicaid Waiver Payments May Be Excludable from Income
The IRS suggests this language: “Under penalties of perjury, I declare that I am an individual care provider receiving payments under a state Medicaid Home and Community-Based Services waiver program for care I provide to [Name of care recipient] who lives in my home under the care recipient’s plan of care.” Give it to whoever issues your pay, and withholding should stop on future checks.
Getting Back Tax You Already Paid
If you paid income tax on qualifying payments in earlier years, you can file Form 1040-X to amend those returns and claim a refund. The current year and the two prior tax years can generally be filed electronically through tax software; older years require a paper form.4Internal Revenue Service. About Form 1040-X, Amended U.S. Individual Income Tax Return
The refund window is firm. You have three years from the date you filed the original return or two years from the date you paid the tax, whichever is later.5Office of the Law Revision Counsel. 26 USC 6511 – Limitations on Credit or Refund After that, the refund is gone even if the exclusion clearly applied. Start with the oldest still-open year.
On the 1040-X, list the original figures, the change amount, and the corrected totals. In Part III, cite IRS Notice 2014-7 and Section 131, and state that you and the care recipient shared a home during the year at issue. Attach or hold the W-2s and 1099s for each amended year along with the original returns.
The Earned Income Credit and Additional Child Tax Credit
Excluding the payments from income normally shrinks the “earned income” figure that drives the EIC and the Additional Child Tax Credit. The IRS gives caregivers a choice: for any open tax year, you can elect to include your excludable Medicaid waiver payments as earned income for EIC and ACTC purposes while still excluding them from taxable income.3Internal Revenue Service. Certain Medicaid Waiver Payments May Be Excludable from Income
The election is all-or-nothing. You either count the full excludable amount as earned income, or none of it; there’s no partial election tuned to a particular credit. The payments also have to be the type that would ordinarily count as earned income, meaning wages or self-employment income. For lower-income caregivers with qualifying children, running the numbers both ways is worth the few minutes it takes.
Payroll Tax and Social Security Credits
The income tax exclusion does not automatically eliminate Social Security and Medicare (FICA) taxes. FICA treatment depends on whether you’re classified as an agency employee, an employee of the care recipient, or an independent contractor, and on domestic-service rules for family members.3Internal Revenue Service. Certain Medicaid Waiver Payments May Be Excludable from Income
This matters beyond the current check. If no FICA is withheld and none is owed, the work doesn’t build Social Security earnings credits. Caregivers who spend years outside traditional employment can end up with lower future retirement benefits because of the gap. That’s the tradeoff worth understanding before assuming the exclusion is pure upside.
Records to Keep
Documentation is what turns an exclusion claim into an audit-proof one. Keep, at minimum:
- The care recipient’s full name and, if available, Social Security or taxpayer identification number.
- Third-party proof that you and the recipient lived at the same address during the year: driver’s licenses, bank statements, medical records, utility bills, or agency documents.
- Evidence that the recipient participates in a state Medicaid waiver, such as the individual plan of care or a letter from the administering agency.
- Copies of W-2s, 1099s, filed returns, any amended returns, and any signed self-certification you gave your agency.
Hold these for at least three years after filing, and longer for any year you amended, since the IRS may review amendments on their own timeline.3Internal Revenue Service. Certain Medicaid Waiver Payments May Be Excludable from Income