Nontaxable Medicaid Waiver Payments: Reporting and EIC Rules

Medicaid waiver payments are nontaxable for federal income tax purposes when the caregiver and the person receiving care live in the same home. Under IRS Notice 2014-7, these amounts are treated as difficulty of care payments excluded from gross income under Internal Revenue Code Section 131.¹ The shared-home rule is where most caregivers get tripped up, and how you report the payments on your return decides whether the exclusion actually reaches your bottom line and whether you keep access to refundable credits worth thousands of dollars.

The Shared-Home Rule Is the Hard Line

The exclusion only applies when care is provided in the home where the caregiver actually lives. If you drive to a family member’s house to provide care and return to your own place at night, the payments do not qualify.¹

The IRS defines the provider’s home as the place where you reside and regularly carry out the routines of your private life, such as sharing meals and holidays with family.² You can meet the rule two ways: you move into the care recipient’s home and make it your actual residence, or the care recipient lives in your household. Occasional overnights or keeping a few belongings at the recipient’s place is not enough. The relationship between caregiver and recipient does not matter. A spouse, adult child, parent, sibling, or unrelated friend all qualify on the same terms.¹

Which Payments Are Covered

The exclusion covers payments for personal care services, habilitation services, and other supports that help the recipient avoid institutional care, provided the services are part of the recipient’s state-approved care plan and the payments flow through a state Medicaid Home and Community-Based Services waiver program.¹ Payments for administrative costs, unrelated travel, or equipment purchases fall outside the exclusion.

Keep a copy of the state-approved care plan with your tax records. If the IRS ever questions the exclusion, that plan is the document showing your payments were for covered services provided in a shared home.

How to Report Nontaxable Medicaid Waiver Payments

State agencies typically issue a tax form even though the income is excludable. You might receive a W-2, a 1099-MISC, or a 1099-NEC.² The steps depend on which form arrived.

Payments on a W-2

Enter the box 1 amount on Form 1040, line 1a. If box 12 shows a Code II amount, enter that on line 1d. Then, on Schedule 1, enter the excludable amount as a negative number on line 8s, which has preprinted parentheses for Medicaid waiver payment exclusions.² That negative amount flows through and reduces your adjusted gross income.

Payments on a 1099-MISC or 1099-NEC

If you are not running a home care business, put the 1099 amount on Form 1040, line 1d, and offset the excludable amount on Schedule 1, line 8s, the same way as W-2 payments.²

If you are a sole proprietor in the business of providing home care, report the full 1099 amount as income on Schedule C, line 1. Then enter the excludable amount as an expense in Part V (Other Expenses) and write “Notice 2014-7” next to it.² The excluded portion is not self-employment income and is not subject to self-employment tax.

Keep the Earned Income Credit and Additional Child Tax Credit

Excluding the payments can shrink your earned income enough to knock you out of the Earned Income Credit or the Additional Child Tax Credit. Both are refundable credits calculated from earned income, and for caregivers with children they can be worth several thousand dollars.

The IRS lets you make an election to include all of your excludable Medicaid waiver payments as earned income when calculating the EIC and the ACTC, while still excluding those payments from gross income for regular tax.² It’s all-or-nothing; you can’t include only part. Done right, the payments stay off your taxable income and still count toward the refundable credits.

Social Security and Medicare Taxes Follow Different Rules

Income tax exclusion does not automatically mean FICA exclusion. Who counts as your employer decides what happens with Social Security and Medicare taxes.²

Independent contractor: payments are not subject to Social Security or Medicare taxes.
State agency as employer of record: payments are subject to FICA even though they’re excludable from income tax.
Care recipient as employer: domestic service rules apply. Payments are subject to FICA unless a standard family exemption fits (you’re caring for a spouse, a child, or a parent while under 21), or total cash wages from that employer are below $3,000 for the calendar year.³

If Social Security or Medicare taxes were withheld in error, contact the agency that withheld them first and request a refund. If the agency won’t refund or file a claim, you can file Form 843 (Claim for Refund and Request for Abatement) with the IRS, attaching a copy of your W-2 and a statement explaining why the withholding was wrong.⁴

Fixing Past Returns

If you paid income tax on Medicaid waiver payments in a prior year without taking the exclusion, or missed the EIC/ACTC election, file Form 1040-X to amend that return.⁵

You generally have three years from the original due date to claim a refund. Once that window closes, the IRS cannot issue a refund for that year even if you clearly overpaid.⁵ A 2023 return due April 15, 2024, would have to be amended by April 15, 2027. If you have several open years to fix, work the oldest one first.

State Income Tax

The federal exclusion reduces your federal adjusted gross income. Most states build their income tax calculation on federal AGI, so the exclusion carries over to your state return automatically. A few states may require a separate adjustment. Check your state’s return instructions or ask your state Medicaid agency how the exclusion is handled where you file.

1
Internal Revenue Service. Notice 2014-7
2
Internal Revenue Service. Certain Medicaid Waiver Payments May Be Excludable From Income
3
Internal Revenue Service. 2026 Publication 926
4
Internal Revenue Service. Instructions for Form 843
5
Taxpayer Advocate Service. Certain Medicaid Waiver Payments May Be Excludable From Income