Are Medicaid Waiver Payments Considered Taxable Income?

In most cases, Medicaid waiver payments are not taxable income for federal purposes. Under IRS Notice 2014-7, money you receive for providing in-home personal care through a state Medicaid Home and Community-Based Services waiver can be excluded from your gross income, as long as you live in the same home as the person you care for and the program operates under Section 1915(c) of the Social Security Act.¹ The IRS treats these as “difficulty of care payments” under Section 131 of the Internal Revenue Code, the same provision that shelters foster care payments.²

That is the short answer. The details below decide whether the exclusion actually reaches your situation, and how to claim it without losing other tax benefits along the way.

The Shared-Home Requirement Is the Deciding Factor

Whether your payments qualify comes down almost entirely to where you live. The exclusion applies when the care happens in your home, meaning the care recipient lives with you, or when it happens in the care recipient’s home and that home is genuinely yours too.¹

The IRS defines “your home” as the place where you carry out the routines of your private life: eating meals, spending holidays, sleeping most nights. If you care for someone five days a week at their house but go home to your own family on weekends and holidays, the payments do not qualify. Their house is your workplace, not your home. If you live full-time with the care recipient and have no separate residence, the shared home is yours, and the exclusion applies.¹

The IRS does not require any particular family relationship, but the residency test naturally favors family arrangements: a parent caring for an adult child with disabilities, an adult child caring for an aging parent, or a spouse providing in-home care.

Which Programs and Services the Rule Actually Covers

Notice 2014-7 specifically applies to waiver programs authorized under Section 1915(c) of the Social Security Act. If your state pays you through a different Medicaid program, the IRS has said the answer depends on that program’s specific design and purpose, with no blanket rule either way.¹ Before you claim the exclusion, confirm the program type with your state Medicaid agency or the fiscal intermediary that issues your payments.

The exclusion covers non-medical personal care: help with bathing, dressing, meal preparation, mobility, and similar activities of daily living. Payments specifically for medical services like nursing or skilled therapy fall outside it.

Section 131 also caps the number of people you can be paid for. You can exclude payments for caring for up to 10 individuals under age 19, and up to 5 individuals age 19 or older.² For most caregivers looking after one or two family members, this never comes into play.

How to Report the Exclusion on Your Return

What you do at tax time depends on how your payer classified you.

If You Get a W-2

When the payer treats you as an employee and handles the paperwork correctly, excludable Medicaid waiver payments appear in Box 12 with Code II, and Box 1 (wages) does not include them.³ Nothing extra is needed on your return in that case.

Some payers still put the full amount in Box 1 by mistake. First, ask for a corrected W-2 (Form W-2c). If you cannot get one, report the Box 1 amount on your Form 1040 and enter the excludable amount as a negative adjustment on Schedule 1, Line 8s, with a note referencing “Notice 2014-7.”⁴ The result is that the income washes out for federal tax purposes.

If You Get a 1099-NEC or 1099-MISC

Receiving a 1099 doesn’t make the payments taxable. Report the income on Line 1d of your Form 1040, then subtract the full excludable amount on Schedule 1, Line 8s, labeled “Notice 2014-7.”¹ The label matters because it tells the IRS why your reported income doesn’t match what the payer filed.

Don’t Lose Your Earned Income Tax Credit

This is where a lot of money gets left on the table. Once you exclude the payments, they disappear from your adjusted gross income. If those payments were most or all of your income, you may look like you have little or no earned income, and that can knock you out of the Earned Income Tax Credit or shrink your Additional Child Tax Credit.

After the IRS lost the Tax Court case Feigh v. Commissioner, it changed course: you may choose to include all of your excluded Medicaid waiver payments as earned income when figuring the EITC and Additional Child Tax Credit, even while those same payments remain excluded from gross income.¹⁵

The election is all-or-nothing. You include every dollar of excluded payments as earned income for credit purposes, or none of them. For a caregiver with qualifying children, the EITC alone can be worth more than $8,000 in 2026, so this election is worth attention. Tax software usually asks whether you received nontaxable Medicaid waiver payments and whether you want to include them for EITC purposes; if you file on paper or use a preparer, make sure the question gets asked.

Social Security, Medicare, and Self-Employment Tax Work Differently

Income tax and payroll tax are separate questions here, and the answers don’t always match.

If you are treated as an independent contractor, the excluded payments are not self-employment income and are not subject to self-employment tax.¹

If you are an employee of an agency, the payments are generally still subject to Social Security and Medicare withholding, even though they are excluded for income tax purposes.¹ Your W-2 may show zero in Box 1 while still showing wages in Boxes 3 and 5.

If the care recipient is your employer, household employment rules apply. FICA is only owed if the care recipient pays you $3,000 or more in cash wages during 2026.⁶

There’s a trade-off worth thinking about. Payments not subject to Social Security tax do not generate Social Security work credits. Over years of caregiving, that can reduce your future retirement or disability benefits. If waiver payments are your main livelihood, weigh the current tax savings against the long-term benefit reduction, and consider talking to a financial planner familiar with caregiver situations.

Refunds for Prior Years You Already Paid Tax

If you paid federal income tax on Medicaid waiver payments in earlier years without knowing about the exclusion, you can file an amended return to recover it. Notice 2014-7 has been in effect since the 2014 tax year.

The refund window is the later of three years from when you filed the original return or two years from when you paid the tax.⁷ File a separate Form 1040-X for each year. In Part II, explain that you are excluding Medicaid waiver payments under Notice 2014-7 that were previously reported as taxable income.⁸ Form 1040-X can be filed electronically for the current year and the two prior years; older years require a paper filing. Attach documents showing that you and the care recipient shared a home in that year and that the program is a qualifying waiver.¹ If you also missed the EITC election in those years, the amended return is your chance to claim it.

State Income Tax May Not Follow

The federal exclusion does not automatically carry over to your state return. States that conform to federal adjusted gross income pick up the exclusion without extra work. States that decouple from the federal rule may treat the same payments as fully taxable at the state level. Check your state tax agency’s guidance before assuming the payments are tax-free everywhere. Getting this wrong can trigger state underpayment penalties.

Records to Keep

If the IRS questions the exclusion, documentation is what settles it. The IRS has identified the kinds of records that support a claim:¹

Proof you and the care recipient share an address, such as a driver’s license, bank statement, medical bill, or utility bill.
A letter or notice from the state Medicaid agency or fiscal intermediary confirming the care recipient is enrolled in a 1915(c) waiver program.
The full name and taxpayer identification number of the person receiving care.
Your W-2, 1099, or payment statements showing what you received during the year.

Keep the records for at least three years after filing the return they support. For amended returns, run the three years from the date of the amendment.

1
Internal Revenue Service. Certain Medicaid Waiver Payments May Be Excludable From Income
2
Office of the Law Revision Counsel. 26 USC 131 – Certain Foster Care Payments
3
Internal Revenue Service. 2026 General Instructions for Forms W-2 and W-3
4
Internal Revenue Service. 1040 (2025) Instructions
5
Internal Revenue Service. Action on Decision – Feigh v Commissioner
6
Internal Revenue Service. 2026 Publication 926
7
Internal Revenue Service. Time You Can Claim a Credit or Refund
8
Internal Revenue Service. Instructions for Form 1040-X