IRS Notice 2014-7: Difficulty of Care Payment Exclusion

Under IRS Notice 2014-7, the difficulty of care payment exclusion lets in-home caregivers leave certain Medicaid waiver payments off their federal taxable income entirely. The payments are treated as difficulty of care income under Section 131 of the Internal Revenue Code, and they drop out of gross income as long as the caregiver and the person receiving care share the same home and the money flows through a qualifying state waiver program.¹ A 2019 Tax Court decision added a valuable wrinkle: you can exclude the income and still count it as earned income when claiming refundable credits like the Earned Income Tax Credit.²

What Payments the Exclusion Covers

The exclusion applies to payments for personal care you provide to a person with a physical, mental, or emotional disability, funded through a state Medicaid Home and Community-Based Services waiver authorized under Section 1915(c) of the Social Security Act.¹ These waivers let states pay for long-term care in a home setting rather than a nursing facility.³

Two payment sources fall outside the rule. Money the care recipient pays you directly out of pocket is not excludable, even if you live together. And payments from state programs that aren’t HCBS waivers may or may not qualify; the IRS looks at those individually, considering “the nature of the payments and the purpose and design of the program.”¹ If your state pays you through a different Medicaid authority, ask before assuming the exclusion applies.

You Must Live With the Person You Care For

Residency is the requirement that decides most claims. The IRS defines the provider’s home as the place where you actually reside and carry on the routines of your private life, like eating meals and spending holidays.¹ The care recipient must live in that same home under their plan of care.

If you keep your own separate residence and travel to the care recipient’s home to work, you don’t qualify, even if you sleep there most nights. The IRS points to the provider who returns home for weekends and holidays: that separate home is where the provider’s private life happens, so the exclusion doesn’t apply.¹ The reverse also fails: if you provide care only at the recipient’s home and it isn’t yours too, the income stays taxable.

Being related to the recipient is neither required nor disqualifying. The IRS cares about the shared living arrangement, not biological or legal ties.⁴

Caps on the Number of Care Recipients

Section 131 limits how many people you can receive excludable difficulty of care payments for. The cap is 10 individuals under age 19 and 5 individuals age 19 or older.⁵ Anything paid for individuals beyond those numbers stays taxable. Most family caregivers never come close, but the cap matters for larger shared-living arrangements.

How the Payments Should Appear on W-2s and 1099s

If you’re paid as an employee, qualifying payments should show up on Form W-2 in Box 12 with Code II, not in Box 1.¹ Code II was created specifically for excludable Medicaid waiver payments. A W-2 that puts the money in Box 1 is wrong, and you can ask the issuer to correct it.

If you’re treated as an independent contractor, the paying agency generally shouldn’t issue a Form 1099-NEC at all once it knows the payments qualify. The IRS lets payers rely on a signed written statement from you confirming that Notice 2014-7 applies.¹ Some agencies issue a 1099-NEC anyway. If yours does, you can still claim the exclusion on your return.

When an agency refuses to correct a W-2, you can attach Form 4852 as a substitute and report the correct figures with an explanation of the discrepancy.⁶

How to Report the Exclusion on Your Return

If your W-2 correctly shows the payments in Box 12 with Code II and nothing in Box 1, your return may already reflect the exclusion without extra work. If any amount was reported as taxable on a W-2 Box 1 or a 1099-NEC, you need to include it and then back it out.

Report the full payment amount on the income line of Form 1040, then enter the same figure as a negative adjustment on Schedule 1, Line 8z. Write “Notice 2014-7” next to that entry.¹ The negative offsets the reported income and returns your adjusted gross income to the right figure. Most tax software handles this in an “Other Income” section.

Self-Employment and FICA Taxes

Payments that qualify under Notice 2014-7 are not subject to self-employment tax. The IRS treats this as following from the exclusion itself: because the money isn’t income, it isn’t self-employment income for SECA purposes, even for a sole proprietor.¹ You don’t file Schedule SE or pay the 15.3% SECA tax on these amounts.

FICA (Social Security and Medicare) works differently. If the care recipient is your employer for payroll purposes, the payments are technically wages that could be subject to FICA. Two common exceptions often eliminate the liability. Payments for domestic services performed for a spouse, a child under 21, or a parent are generally exempt from FICA. And if total domestic service wages from one household fall below the annual threshold ($2,800 for 2025), FICA doesn’t apply. Whether either exception fits depends on the employment structure your state’s program uses.

Claiming the EITC and Additional Child Tax Credit

The Tax Court’s decision in Feigh v. Commissioner held that Medicaid waiver payments excluded under Notice 2014-7 still count as earned income for the Earned Income Tax Credit and the Additional Child Tax Credit. The IRS agreed to follow the ruling.²

That combination is powerful. A caregiver whose only income is $25,000 in waiver payments owes no federal income tax on that money, and can still use the same $25,000 as earned income for EITC and ACTC calculations. Depending on household size and filing status, the refund can reach several thousand dollars.

Treating the excluded payments as earned income for credit purposes is an election, not a requirement. You make it only when it produces a better outcome, which it usually does for lower-income caregiving households. The payments must otherwise meet the definition of earned income under Section 32, meaning they compensate you for services you actually performed.⁷

Amending Past Returns to Claim the Exclusion

If you paid tax on waiver payments in earlier years without claiming the exclusion, file Form 1040-X to amend those returns and request a refund.⁸ Reference Notice 2014-7 in the explanation.

The deadline is generally three years from when you filed the original return or two years from when you paid the tax, whichever is later.⁹ A return filed April 15, 2024, is generally amendable through April 15, 2027. Amended returns take roughly 120 days to process.¹⁰

Records to Keep

If the IRS questions the exclusion, the burden is on you to show the payments qualify. Keep the following:

Documents showing the care recipient is enrolled in a qualifying 1915(c) HCBS waiver program.
The written plan of care authorizing services in your home.
Payment records from the state agency or fiscal intermediary listing amounts and dates of service.
Proof that you and the care recipient share an address, such as utility bills, a lease, or official mail.
All W-2s and 1099s you receive, plus any corrected versions and any Form 4852 you filed.

Keep these for at least three years after filing the return, matching the standard IRS audit window. For an amended return, run the three years from the date you filed the amendment.¹¹

1
Internal Revenue Service. Certain Medicaid Waiver Payments May Be Excludable From Income
2
Internal Revenue Service. Action on Decision – Feigh v. Commissioner
3
Medicaid. Home and Community-Based Services 1915(c)
4
Internal Revenue Service. Notice 2014-7
5
Office of the Law Revision Counsel. 26 USC 131 – Certain Foster Care Payments
6
Internal Revenue Service. About Form 4852, Substitute for Form W-2, Wage and Tax Statement, or Form 1099-R
7
Office of the Law Revision Counsel. 26 USC 32 – Earned Income
8
Taxpayer Advocate Service. Certain Medicaid Waiver Payments May Be Excludable From Income
9
Internal Revenue Service. Time You Can Claim a Credit or Refund
10
Taxpayer Advocate Service. Held or Stopped Refunds
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Office of the Law Revision Counsel. 26 US Code 6511 – Limitations on Credit or Refund