IRS Notice 2014-7: Income Exclusion for Care Providers

IRS Notice 2014-7 provides guidance for individual care providers, clarifying the federal income tax treatment of certain payments they receive. The notice specifically addresses whether payments from state Medicaid Home and Community-Based Services waiver programs can be excluded from the provider’s gross income. This guidance was issued to resolve uncertainty for providers receiving these specific types of payments.

Scope of the Income Exclusion

The core of Notice 2014-7 allows certain payments to be treated as “difficulty of care payments,” making them excludable from a provider’s gross income. This treatment is based on Internal Revenue Code Section 131, which originally applied to foster care payments. The notice extends this concept to payments made under a state Medicaid waiver program for personal care services, such as meal preparation, laundry, and assistance with daily living.

For the income to be excludable, the payment must originate from a state Medicaid Home and Community-Based Services (HCBS) waiver program. The services must be for an eligible individual with a physical, mental, or emotional handicap. A requirement is that the care is provided within the home of the individual care provider. This exclusion applies regardless of the biological relationship between the provider and the person receiving care.

The exclusion has limitations based on the number of individuals being cared for in the provider’s home. The tax-free treatment of payments applies for up to five qualified individuals who are age 19 or older. If the individuals receiving care are under the age of 19, the exclusion applies to payments for up to ten individuals.

The exclusion specifically applies to payments for personal care and relief care. It does not extend to payments for services like respite care, skills acquisition training, or compensation for travel time. Direct payments from the care recipient, often known as “client participation” amounts, are not covered by this exclusion and remain taxable income.

Defining the Provider’s Home

A point of clarification in Notice 2014-7 is the definition of the “provider’s home.” The IRS has affirmed that the location of care qualifies as the provider’s home even if the provider does not own or rent the property. The key factor is that the provider and the care recipient share the same household.

This means the income exclusion can still apply if the care provider resides in a home that is owned or rented by the individual receiving care. For example, consider an adult child who moves into their elderly parent’s house to provide full-time care. Even though the parent owns the home, because the child now lives there and provides care in that shared residence, the location is considered the provider’s home.

This interpretation ensures that the tax benefit is not limited by property ownership or lease agreements. Providers in these situations can self-certify their living arrangement with the paying agency to ensure the payments are properly categorized and excluded from federal and state income tax withholding. If the living arrangement changes, the provider must update their status with the agency.

Applying the Notice to Tax Filings

The guidance in Notice 2014-7 is retroactive, meaning it can be applied to previously filed tax returns. This allows providers who may have incorrectly reported these payments as taxable income to correct their records and potentially receive a refund.

For prior years, a provider can file an amended U.S. Individual Income Tax Return using Form 1040-X. Generally, a return can be amended for up to three years from the date it was filed or two years from the date the tax was paid, whichever is later. When filing the amended return, the taxpayer should cite Notice 2014-7 as the reason for the change and include documentation from the paying state agency that identifies the payments.

For current and future tax years, providers should exclude qualifying payments from the gross income reported on their Form 1040. If a paying agency issues a Form W-2, it may correctly report the nontaxable payments in Box 12 with the code “II”. However, if the payments are included in Box 1 (Wages), the provider should still exclude the income on their Form 1040 but may need to attach an explanation for the difference.

If the provider receives a Form 1099-NEC or 1099-MISC for these payments, they should report the full amount on Schedule C and then deduct the same amount as an “Other Expense,” with the notation “Notice 2014-7” to zero out the income.

While the payments are not included in gross income, taxpayers have the option to include them as earned income when calculating the Earned Income Tax Credit (EITC) and the Additional Child Tax Credit (ACTC). This choice can potentially increase the amount of these credits, providing a tax benefit to eligible providers.