Medicaid Waiver Payments and Taxes: What Caregivers Need to Know

A practical guide to the federal income tax exclusion, earned-income election, Form W-2 reporting, employment taxes, amended returns, and caregiver records.

Qualifying Medicaid waiver payments can produce two federal tax results at the same time. A caregiver may exclude the payments from gross income under IRS Notice 2014-7 and still choose to count the entire qualifying amount as earned income when calculating the Earned Income Tax Credit or the Additional Child Tax Credit. The best choice depends on the payment, living arrangement, work status, and the caregiver's complete tax return.

The rules do not apply to every payment made to a family caregiver. Notice 2014-7 generally covers qualifying payments made through a state Medicaid Home and Community-Based Services waiver program for care provided under the recipient's plan of care in the caregiver's home. Payments under certain other state-administered in-home care programs may require a separate analysis based on the program's purpose and design and the nature of the payments.

What Are Medicaid Waiver Payments?

State Medicaid Home and Community-Based Services waiver programs allow eligible individuals who might otherwise require institutional care to receive approved services in a home or community setting. Covered support may include help with eating, bathing, dressing, personal hygiene, light housekeeping, laundry, meal preparation, transportation, medication management, and other services authorized in the plan of care.

Notice 2014-7 addresses certain payments made by a state, a political subdivision, or a certified Medicaid provider to an individual care provider for nonmedical support services. The recipient may be related or unrelated to the caregiver. An informal family payment, private reimbursement, or ordinary home-care wage is not converted into a qualified Medicaid waiver payment simply because the person receiving care is eligible for Medicaid.

When the Federal Income Tax Exclusion May Apply

The IRS treats qualified Medicaid waiver payments as difficulty-of-care payments excludable from gross income under section 131 when the required conditions are satisfied. For most family caregivers, the shared-home requirement is the fact that receives the closest review.

Facts that support the exclusion	Facts that do not satisfy Notice 2014-7 by themselves
Payments are made through a state Medicaid Home and Community-Based Services waiver program.	The caregiver is paid under an informal family arrangement or from the recipient's private funds.
The eligible care recipient lives in the caregiver's home under an approved plan of care.	The caregiver works or sleeps in the recipient's home but maintains a separate principal home elsewhere.
The caregiver resides in the recipient's home, treats it as the caregiver's own home, and has no separate home.	Respite care is provided in the recipient's home or the caregiver's home when the recipient does not live there.
The payment is for authorized care of the eligible individual in the shared home.	Vacation pay, direct private payments, or unrelated compensation is mixed with the waiver payment.

The statutory difficulty-of-care limits also matter. The exclusion is limited to payments for no more than 10 qualified individuals who have not attained age 19, or five qualified individuals who have attained age 19. Most family-care situations fall well below those limits, but professional or multi-recipient arrangements require a closer review.

If the shared-home or program requirements are not met, Notice 2014-7 does not exclude the payment from income. Another tax rule might apply, but that requires a separate analysis.

What Counts as the Caregiver's Home?

The IRS looks to where the caregiver resides and regularly carries out private-life routines, such as shared meals and holidays. A caregiver who moves into a parent's home, treats that home as the caregiver's residence, and has no separate home may satisfy the test. A caregiver who stays several nights a week but returns to a separate family home generally does not.

More than one caregiver can qualify for payments involving the same recipient if each caregiver lives in the shared home and the other requirements are met. The relationship between caregiver and recipient is not the deciding factor. Residence, program authority, plan-of-care facts, and the nature of the payment are more important.

Income Tax Exclusion Does Not Settle Employment Taxes

Notice 2014-7 addresses federal gross income. Social Security and Medicare tax depend on who is the employer, whether the caregiver is an employee or independent contractor, and whether a domestic-service exception applies. Worker classification is based on the right to direct and control the services, not only on the label used by a state agency or payment processor.

1. Agency employee: Qualified payments are generally subject to Social Security and Medicare tax when the paying agency is the caregiver's employer, even though the payments are excluded from federal gross income.

2. Employee of the care recipient: Domestic-service rules apply when the care recipient is the employer. Family-relationship and annual wage exceptions may change the result.

3. Independent contractor or sole proprietor: IRS guidance says qualified excludable payments are not self-employment income when received by an independent contractor or a sole proprietor, but nonqualifying payments and other business income require separate treatment.

The EITC and ACTC Earned-Income Election

In Feigh v. Commissioner, the Tax Court held that Medicaid waiver payments treated as excludable under Notice 2014-7 could still be earned income for the Earned Income Credit and the Additional Child Tax Credit. The IRS later acquiesced in the result. Current IRS guidance allows the caregiver to choose to include the payments in earned income for these credits when the payments are otherwise wages or self-employment income.

All or none for each caregiver: The election applies to all, but not part, of that caregiver's qualifying payments. On a joint return, spouses who both received qualified payments may make different choices for their respective payments.

The election does not turn the excluded payment into taxable gross income. It changes the earned-income figure used for the credit calculation. Because the EITC increases over one income range and phases out over another, a larger earned-income figure does not always produce a larger EITC. The ACTC follows its own limits. Prepare the return both ways before choosing.

How Medicaid Waiver Payments Are Reported

Reporting depends on the information form, worker classification, and whether the caregiver makes the earned-income election. The following line references apply to 2025 federal returns filed in 2026. Forms, instructions, and line numbers may change for later tax years.

1. Review Form W-2 carefully. Nontaxable Medicaid waiver payments may appear in box 12 with code II rather than box 1. If box 1 is blank or zero and the caregiver does not elect to count the code II payment as earned income for the EITC or ACTC, the IRS says the code II amount generally does not need to be entered on the federal return.

2. Report an earned-income election correctly. When the caregiver chooses to count nontaxable payments as earned income, the applicable amount is included in the earned-income lines and the nontaxable amount is removed from gross income through Schedule 1. Do not simply add the payment to taxable wages.

3. Reconcile Forms 1099. A caregiver without a separate home-care trade or business generally reports a Form 1099 amount using the individual-return instructions and excludes the nontaxable amount on Schedule 1. A sole proprietor generally reports the gross amount on Schedule C and shows the excludable amount as an other expense labeled Notice 2014-7.

4. Do not ignore payroll tax entries. Box 3 and box 5 wages or withholding can remain even when box 1 is blank because the federal income tax exclusion and FICA treatment are separate questions.

Can a Prior Return Be Amended?

A caregiver may be able to amend an open return to exclude qualified payments that were previously reported as taxable or to make an earned-income election that improves the EITC or ACTC. The general refund-claim deadline is the later of three years from the date the original return was filed or two years from the date the tax was paid. Special timing and refund lookback limits can apply.

IRS guidance recommends including the care recipient's full name and taxpayer identification number, if available, proof that the caregiver and recipient lived in the same home during the year, and evidence that the care was provided through a state Medicaid waiver program. An amendment can also change deductions, credits, or other tax items, so the entire return should be recomputed.

Records Caregivers Should Keep

1. Program documents: State program enrollment records, waiver authorization, and the recipient's plan of care.

2. Payment records: W-2s, Forms 1099, payment summaries, paystubs, and year-end statements.

3. Residence evidence: Driver's licenses, agency correspondence, bank statements, medical bills, or utility bills showing the caregiver and recipient shared the home.

4. Employment-tax records: Worker-classification documents and records of Social Security and Medicare tax withheld or paid.

5. Tax-return support: Prior returns, credit worksheets, amended returns, and notes showing whether the earned-income election was made.

Common Medicaid Waiver Payment Mistakes

1. Assuming every payment to a family caregiver is excluded from income.

2. Ignoring the shared-home test or failing to document the caregiver's principal home.

3. Treating the income tax exclusion as an automatic exemption from Social Security and Medicare tax.

4. Electing to include only part of one caregiver's qualifying payments in earned income.

5. Assuming the earned-income election always increases the EITC without calculating both scenarios.

6. Reporting code II payments as taxable wages without the corresponding Schedule 1 exclusion.

The Bottom Line

Qualified Medicaid waiver payments can be excluded from federal gross income while still being available for an earned-income election for the EITC and ACTC. That favorable treatment depends on specific facts, especially the state waiver program, the approved plan of care, the shared home, and the caregiver's work status.

The safest approach is to reconcile every W-2 or Form 1099, keep proof of the shared home and waiver arrangement, model the credit election both ways, and review employment taxes separately. A well-supported return helps substantiate the exclusion and demonstrates how the caregiver determined the allowable credit treatment.

Need help reviewing caregiver payment records? Brilliant Solutions Group can help organize payment records, reconcile tax forms, and identify questions that need individualized tax review. Contact Brilliant Solutions Group.

Sources

Official sources reviewed for this article. Tax laws, forms, regulations, and IRS guidance can change.

IRS Medicaid Waiver Payment Questions and Answers (shared-home test, earned-income election, W-2 code II, Forms 1099, employment taxes, and amended-return support; accessed August 25, 2026)

IRS Notice 2014-7 (qualified Medicaid waiver payments and difficulty-of-care exclusion)

IRS Action on Decision 2020-2 (Feigh v. Commissioner and earned-income treatment for the EITC and ACTC)

IRS 2025 Form 1040 and 1040-SR Instructions (line 1d, Schedule 1 line 8s, code II, and separate spousal elections)

IRS Publication 596, Earned Income Credit (Medicaid waiver payments in the EITC earned-income calculation)

IRS Instructions for Schedule 8812 (Additional Child Tax Credit earned-income worksheet)

IRS Instructions for Form 1040-X (amended returns and refund-claim timing)

IRS Publication 926, Household Employer's Tax Guide (domestic-service wage thresholds and family-employment exceptions)

IRS Tax Topic 762, Independent Contractor vs. Employee (worker classification and identification of the employer)

Taxpayer Advocate Service: Medicaid Waiver Payments (May 2026 caregiver overview, records, and refund reminders)

Important: This article provides general federal tax information and is not tax, legal, medical, benefits, or financial advice. Results depend on the program, living arrangement, worker classification, forms, return year, and guidance in effect. State rules may differ. Consult qualified advisors before filing or amending a return.