Are Certain Foster Care Payments Taxable? Medicaid Waivers and IRC 131

11/16/2021|John R. Dundon II, EA|Medicaid Waiver

The intent of this article is to address the extent to which private for profit and non-profit agencies that place individuals in need of foster care in foster homes as well as parents of disabled children may have certain tax reporting and payment obligations pertaining to the receipt of Medicaid waiver payments for services rendered in good faith.

Bottom line is that ‘qualified foster care placement agencies’ making ‘qualified foster care payments’ and ‘difficulty of care payments’ to foster care providers for care of ‘qualified foster individuals’ as defined in IRC 131 Certain Foster Care Payments are generally excluded from income tax reporting requirements but there are pitfalls to understand and avoid.

Definitions Re: IRC § 131 – Certain Foster Care Payments

For tax years beginning in 2002 a ‘qualified foster care payment’ is any payment made pursuant to a foster care program of a State or political subdivision thereof that is paid by either a state or political subdivision thereof or a qualified foster care placement agency that is in fact paid to the foster care provider for caring for a qualified foster individual in the foster care provider’s home, or is deemed a difficulty of care payment.

A ‘qualified foster care placement agency’ is any placement agency that is licensed or certified by a state of political subdivision thereof, or an entity designated by a state or a political subdivision thereof, to make foster care payments to foster care providers within the foster care program of such state or political subdivision.

A ‘qualified foster individual’ is any individual who is living in a foster family home in which such individual was placed by an agency of a State or political subdivision thereof or a qualified foster care placement agency.

A ‘difficulty of care payment’ is a payment that is additional compensation for providing the additional care of a ‘qualified foster individual’ that is required by reason of a physical, mental, or emotional handicap of such individual with respect to which the State has determined that there is a need for additional compensation for care services rendered in the home of the foster care provider and is designated by the payor as compensation for providing additional care.

Summary

Foster care payments satisfy the criteria set forth in IRC Section 131 as amended by the Job Creation and Worker Assistance Act of 2002, Pub. L. No. 107-147 (2002) and clarified in IRB 2014-04
- Both qualified foster care payments as well as difficulty of care payments to qualified foster care providers for care of qualified foster individuals are excluded from taxable income for income tax reporting purposes.
- Generally, member agencies as defined under IRC 131 should ALSO not be required to issue IRS Form 1099 with respect to qualified foster care payments made.

However, tread lightly because in some instances those payments for qualified services rendered may require Social Security and Medicare withholding. Also, some states may require unemployment reporting.

Proper worker classification of care providers is instrumental in maintaining federal and state reporting compliance.
If for example the care provider is an employee of qualified service provider, wages still will be subjected to Social Security and Medicare withholding EVEN WHEN EXCLUDED FROM INCOME.
If the care provider is an independent contractor, the payments are not subject to Self Employment tax to fund Social Security and Medicare taxes.

Worker classification determinations tend to generally distill down to the nature of the control of the relationship between the purported employer and purported employee.

Who determines the care providers actual work product, specifically how the work gets done is paramount in making a worker classification determination. Most all workers it seems prefer to be treated as an independent contractor until they get injured on the job, terminated or apply for unemployment.

Worker status – employee v. independent contractor depends on whether the agency or the care recipient has the right to direct and control how the care provider performs services.

IRS Tax Topic 762 can help determine worker classification status. Be advised that worker classification is ALSO determined at the state level and MOST states have more restrictive determinations of employee v. independent contractor status than the IRS.

In Colorado without a written, signed independent contractor agreement, a deemed employer/employee relationship exists.

Payments for services performed for a spouse or a child and services performed for a parent by a child under the age of 21 however generally are not subject to social security and Medicare taxes.
Household Employment status – If the care recipient is the employer of the individual care provider, the FICA tax rules for domestic service (household work done in or around the employer’s home) will apply.
However, if wages for domestic services paid during a calendar year are below a threshold ($2,200 for 2020), those wages are not subject to social security and Medicare taxes.
See IRS Publication 926 for more exceptions.

The excludability from income of payments to care providers caring for related individuals in their home

First a little ‘unfavorable & misguided’ history

The IRS historically has challenged the excludability of payments to individual care providers caring for related individuals in the provider’s home.

Alexander v. Commissioner, T.C. Summary Opinion 2011-48 4-12-11
- Medicaid waiver payments to taxpayers caring for a taxpayer’s parents residing in the taxpayers’ home are not excludable under § 131 because the taxpayers did not show that:
  - they operated a “foster family home” under state law
  - parents were not “placed” in the taxpayers’ home by the state.
Bannon v. Commissioner, 99 T.C. 59 (1992)
- Payments received by the taxpayer for caring for her adult disabled daughter residing in the taxpayer’s home under a state program for in-home supportive services are not excludable under the general welfare exclusion.
- Reinforced by Harper v. Commissioner, T.C. Summary Opinion 2011-56, filed May 2, 2011.
Program Manager Technical Advice (PMTA 2010-007)
- A biological parent of a disabled child may not exclude payments under § 131 because the ordinary meaning of foster care excludes care by a biological parent.

WHY was THIS

IRC §131 does not explicitly address whether payments under Medicaid waiver programs are qualified foster care payments.

However REASON eventually prevailed

On January 3, 2014, the IRS issued Notice 2014-7, 2014-4 I.R.B. 445 providing guidance on the federal income tax treatment of certain payments to individual care providers for the care of eligible individuals under a state Medicaid Home and Community-Based Services waiver program.
- The notice provides that the Service will treat these Medicaid waiver payments as difficulty of care payments excludable from gross income under § 131 of the Internal Revenue Code.
Medicaid waiver programs and state foster care programs share similar oversight and purposes.
- The purpose of Medicaid waiver programs and the legislative history of §131 reflect the fact that home care programs prevent the institutionalization of individuals with physical, mental, or emotional handicaps.
- 128 Cong. Rec. 26905 (1982) states that “difficulty of care payments are not income to the foster parents, regardless of whether they, dollar for dollar only cover expenses.
Parents are saving the taxpayers’ money by preventing institutionalization of these children; allowing Medicaid waivers for home and community-based services, as “permitting the Secretary to waive the current definition of covered Medicaid services to include certain nonmedical support services, other than room and board, which are provided pursuant to a plan of care to an individual otherwise at risk of being institutionalized and who would, in the absence of such services be institutionalized.”
These programs require state approval and oversight of the care of the individual in the provider’s home & share the objective of enabling individuals who otherwise would be institutionalized to live in a family home setting rather than in an institution.
Both difficulty of care payments and Medicaid waiver payments compensate for the additional care required.

A little MORE History… before we get to GUIDANCE

Before the enactment of IRC 131 in 1983, the IRS issued two revenue rulings generally addressing the federal income tax treatment of foster care payments regardless of where the care was provided.

In Rev. Rul. 68-97, 1968-1 C.B. 34, the IRS considered the federal tax treatment of monthly subsidies paid to foster parents who provided emergency shelter care.
- The IRS cited IRC 61(a), which provides the general rule that gross income means all income from whatever source derived, and concluded that the payments to the foster parents were included in gross income.
- Consequently, the IRS reasoned that the payments were subject to the information reporting requirements of IRC 6041 such that the payor was required to issue Form 1099 to all payees that received $600 or more in the taxable year.

In Rev. Rul. 77-280, 1977-2 C.B. 14, the IRS considered four different fact patterns involving foster care and determined that a Form 1099 was required to be issued to the foster parents who made a profit from caring for foster children and, thus, were engaged in a trade or business that really are not worth going into as they are all water under the bridge at this point.

However, these revenue rulings pre-date the enactment of IRC 131 and are based on the general rule that foster care payments are included in gross income. Because IRC 131 provides a statutory exclusion from gross income for qualified foster care payments, these above revenue rulings do not apply to foster care payments.

Historically the question of whether foster care payments were excluded from gross income used to depend on the age of the foster individual and the organization or agency that placed the individual in a foster home.

Again, historically for individuals under the age of 19 payments to foster care providers were excluded from gross income only if the individual was placed in a foster home by an agency of the State or political subdivision thereof.

For individuals age 19 and over, payments to foster care providers were excluded from gross income only of the individual was placed by an agency of the State or political subdivision thereof. Moreover, qualified foster care payments could only be made by a State of political subdivision thereof or a tax-exempt placement agency.

Public Law 107-147 modified IRC 131 in two respects as summarized by the Joint Committee on Taxation (JCT).

The Act expands the definition of qualified foster care payments to include payments by any placement agency that is licensed or certified by a State or local government, or an entity designated by a State of local government to make payments to providers of foster care.
The Act expands the definition of a qualified foster care individual by including foster care individuals placed by a qualified foster care placement agency regardless of the individual’s age at the time of placement.

Although the legislative history to these changes is sparse, the modifications to IRC 131 had been considered as part of the Taxpayer Refund Act of 1999 and the Financial Freedom Act of 1999.

The JCT stated then that the purpose of the proposal was to “allow State and local governments to employ both tax-exempt and taxable entities to administer their foster care programs more efficiently.”

Guidance

Difficulty-of-care payments to foster care providers are not reportable if paid for fewer than 11 children under age 19 and fewer than six individuals age 19 or older as per IRC 131(c).
Certain payments received by an individual care provider under a state Medicaid Home and Community-Based Services Waiver (Medicaid waiver) program, described in this notice, are difficulty of care payments excludable under § 131 of the Internal Revenue Code.
Amounts paid for more than 10 children or more than five other individuals are reportable on IRS Form 1099-NEC.
Certain Medicaid waiver payments may be excludable from income as difficulty-of-care payments.
For more information, see IRS Notice 2014-7 and Medicaid waiver payments frequently asked questions (FAQs)
Even if payments you make to your employees for their services are excludable from gross income for federal income tax purposes, they generally are wages for social security and Medicare tax purposes.
- Be sure to file IRS Forms 941, 940 and appropriate state unemployment forms
Treatment of qualified Medicaid waiver payments under § 131
- To achieve consistent federal tax treatment of Medicaid waiver payments among the states and individual care providers, as of January 3, 2014, the Service will treat qualified Medicaid waiver payments as difficulty of care payments under § 131(c) that are excludable under § 131
- This treatment will apply whether the care provider is related or unrelated to the eligible individual.
- As of January 3, 2014, the Service will no longer conclude that a caregiver of a biological relative receiving qualified Medicaid waiver payments may not qualify as a foster care provider under § 131.
- Payments are excludable as difficulty of care payments only if the care is provided to a “qualified foster individual,” meaning any individual who is living in a “foster family home” in which the individual was “placed” by an agency of a state or a political subdivision thereof, or a qualified foster care placement agency. Section 131(b)(2).
The term “foster family home” is not defined under § 131.
- However, the Tax Court has concluded that, for purposes of § 131, “a person’s ‘home’ is where he resides.” SeeStromme v. Commissioner, 138 T.C. 213, 218 (2012), citingDobra v. Commissioner, 111 T.C. 339 (1998).
- Therefore, an eligible individual receiving care under a Medicaid waiver program lives in a “foster family home” because the eligible individual is a qualified “foster” individual who receives care in a “family home” setting, as opposed to an institution, where the individual care provider also resides.

Medicaid waiver payments made to a provider for care outside of the home where the provider resides are not qualified Medicaid waiver payments and are not excludable under § 131.

The term “placed” is not defined in § 131.
- Under state foster care programs, a state or political subdivision thereof, or a qualified foster care placement agency, may assist in locating a home that meets the qualified foster individual’s needs, negotiate or approve the foster care payment rates, and contract with the foster care providers for the provision of foster care.
- The Tax Court has determined that these activities constitute “placement” for purposes of § 131(b)(2).
- Micorescu v. Commissioner, T.C. Memo 1998-398. States perform similar activities with respect to individuals participating in Medicaid waiver programs.
- Under a Medicaid waiver program, a state, an agency of a state or political subdivision thereof, or a certified Medicaid provider may assist in locating a home for an eligible individual or approve the eligible individual’s choice to reside in the individual care provider’s home, approve an eligible individual’s plan of care, assess the suitability of the home for fulfilling the eligible individual’s plan of care, and enter into a contract or other arrangement with the individual care provider for services provided to the eligible individual.

Thus, an eligible individual receiving care in the home of the individual care provider under the Medicaid waiver program will be treated as “placed” by an agency of a state or political subdivision thereof, or a qualified foster care placement agency, for purposes of § 131.

Accordingly, an eligible individual receiving care in the individual care provider’s home under a Medicaid waiver program is a “qualified foster individual” under § 131(b)(2). Section 131(d)(2) provides that a provider may not exclude payments for the care of more than 10 eligible individuals under age 19 or more than five eligible individuals who are age 19 or over.

Because qualified Medicaid waiver payments are difficulty of care payments, they are subject to these limits as well.

State Medicaid waiver programs

Under § 1915(c) of the Social Security Act (42 U.S.C. § 1396n(c)), a state may obtain a Medicaid waiver that allows the state to include in the state’s Medicaid program the cost of home or community-based services (other than room and board) provided to individuals who otherwise would require care in a hospital, nursing facility, or intermediate care facility as eligible individuals.

Home or community-based services include personal care services, habilitation services, and other services that are “cost effective and necessary to avoid institutionalization.”
As per 42 C.F.R. § 440.180. Personal care services are defined under rules of the Centers for Medicare and Medicaid Services to include assistance with eating, bathing, dressing, toileting, transferring, maintaining continence, personal hygiene, light housework, laundry, meal preparation, transportation, grocery shopping, using the telephone, medication management, and money management.
Habilitation services, defined in 42 U.S.C. § 1396n(c)(5)(A), assist individuals in acquiring, retaining, and improving the self-help, socialization, and adaptive skills necessary to reside successfully in home and community-based settings.

Skilled services that only a health professional may perform are not personal care services.

Medicaid waiver programs generally do not compensate a family member for providing personal care services to an eligible individual if the family member is legally responsible for the individual as a minor child as per 42 C.F.R. § 440.167(a)(2) and (b).
Some states compensate family members, as well as unrelated individual care providers, for residential habilitation, foster/companion care, or transportation services provided as a part of an eligible individual’s plan of care.

A plan of care is a term defined by the state, but generally means an individualized plan of treatment, services, and/or providers.

A state, directly or indirectly through an agency under contract with the state, certifies individuals and entities as Medicaid providers to provide services to eligible individuals.
An entity that is a certified Medicaid provider may contract with an individual care provider to care for an eligible individual in the care provider’s home.
A state or an agency under contract with the state approves the plan of care for the eligible individual in the provider’s home and monitors the eligible individual’s care.

Other Important Facts

A “provider’s home” means the place where the provider resides and regularly performs the routines of private life as per Stromme v. Commissioner, 138 T.C. 213 (2012).
If you move into your mother’s home to serve as her care provider your mother’s home becomes where you reside and regularly perform the routines of private life.
If you care for an unrelated person five days a week in her home and are required to sleep there four nights a week. I receive Medicaid waiver payments for this care but maintain a separate residence on weekends and holidays you are deemed to work in the care recipient’s home and do NOT ‘provide care for the care recipient in the provider’s home’ and may not exclude the Medicaid waiver payments from gross income.
If you care for an unrelated person seven days a week in their home where you live and do NOT have another home you may exclude Medicaid waiver payments from gross income.
More than one care provider living in the home with the care recipient may exclude state Medicaid Home and Community-Based waiver payments from gross income under Notice 2014-7.
The exclusion of Medicaid waiver payments from income only applies to payments for care in the individual care provider’s home where the care recipient lives under the recipient’s plan of care.
You may exclude the entire payment that you receive under the state Medicaid waiver program for the care of a disabled individual in your home even though the individual is required to pay an administrator part of the cost of the care.
- However, you may NOT exclude direct payments from a care recipient who pays with private funds.
- Also, some states pay care providers vacation pay as part of a care plan. Vacation pay IS reported as taxable income.
You may choose to include all, but not part, of Medicaid waiver payments in earned income for determining the Earned Income Credit (EIC) or the Additional Child Tax Credit (ACTC).
You may file a Form 1040-X, Amended U.S. Individual Income Tax Return, if you received payments described in the notice in an earlier year and the time for claiming a credit or refund has not expired under § 6511 of the Internal Revenue Code.
- A claim for refund is generally recognized within three years from the date the return was filed or two years from the date the tax was paid, whichever is later.
- Excluding payments described in the notice in an earlier year may affect deductions or credits that you claimed for the earlier year, as well as other tax items for the earlier year.
- To help expedite the processing of your amended return, you should include the following to substantiate your claim:
  - the full name of the individual receiving care (and the care recipient’s social security number or other taxpayer identifying number, if available)
  - copies of documents from third parties to show that you and the individual receiving care resided in the same home in the year to which the claim relates (such as a driver’s license or other government-issued document, social agency document, bank statement, medical bill, or utility bill)
  - any available evidence that the individual is receiving care under a state Medicaid waiver program
If you receive wage payments that are excludable from gross income under Notice 2014-7 & your employer withholds federal income tax on the payments reporting the payments as wages in box 1 of Form W-2 you should include the full amount of the payments reported in box 1 of Form W-2 as wages on line 1 of Form 1040 or Form 1040-SR and then subtract the excludable portion of the amount in box 1 on Schedule 1, line 8, “Other income”
- You may need to enter a negative amount on Schedule 1, line 8, if you have no other income reportable on Schedule 1, line 8, or if the amount of other income you must report on Schedule 1, line 8 is less than the amount excludable from gross income.
- You should write “Notice 2014-7” on the dotted line for Schedule 1, line 8,if you file a paper return, or enter “Notice 2014-7” on Schedule 1, line 8 for an electronically filed return.
If social security and Medicare taxes were withheld in error contact the agency that withheld the taxes for a refund.
- IF the agency does not comply a refund of the erroneously withheld social security and Medicare taxes may be claimed by filing IRS Form 843, Claim for Refund and Request for Abatement.
If you inappropriately receive IRS Form 1099-misc IRS Form 1099-NEC as a care provider for services provided that are excludable from income as per IRC 131 you should first ask the issuer to ‘correct’ and reissue the form asserting $0
- Should the issuer fail to comply with your request enter -0- on line 21 of Form 1040 – assuming you have no other income reportable on line 21. and enter “Notice 2014-7”
If you are in the business of providing home care services and receive payments that are excludable from gross income under Notice 2014-7 AND IRS Form 1099-MISC or IRS Form 1099-NEC you should include the full amount of the payments reported to you as income on line 1 of Form 1040 (Schedule C).
- Then report the excludable amount as an expense in Part V, and write “Notice 2014-7” next to that amount.
For additional Q&As discussing the application of self-employment tax to family caregivers, follow this link:/Businesses/Small-Businesses-&-Self-Employed/Family-Caregivers-and-Self-Employment-Tax.
Any amount excludable from gross income should not be included in box 1, Wages, tips, other compensation, of the employee’s Form W-2. If the entire amount you pay to the employee during the year is excludable from his or her gross income, box 1 of Form W-2 should be left blank.

What About Information Reporting Requirements?

Surprisingly, there is no explicit statutory provision that excludes certain ‘foster care payments’ from the requirement of being reported on Form 1099. Moreover, the IRS has provided no formal published guidance regarding the reporting of payments excluded from income, including the qualified foster care payments, in the form of regulations or revenue rulings.

IRC § 6041 refers to reporting ‘income’ whereas the exclusions typically refer to exclusions from ‘gross income’ defined in IRC 61.

Ordinarily the absence of such guidance suggests that no such exemption exists that may be relied upon by taxpayers because exemptions from a statutory mandate are to be narrowly construed according to Bingler v. Johnson, 394 U.S. 741, 752 (1969)

With that as a back drop the IRS appears to have accepted that amounts excluded from gross income need not be reported on From 1099.

For more on whether Certain Foster Care Payments Taxable? Medicaid Waivers and IRC 131 contact me.