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Medicaid Waiver Payments Were Earned Income Even Though the IRS Excluded Them from Gross Income

IRS Excludes Medicaid Waiver Payments from Gross Income

Taxpayers can receive payments under a state Medicaid waiver program for providing nonmedical care in their homes to eligible individuals. Internal Revenue Code (IRC) Section 131 excludes foster care payments from gross income, but it applies only when the foster individuals are placed in the caregiver’s home by the state. Despite the statutory language, however, IRS Notice 2014-7 treats Medicaid waiver payments as excludable “difficulty of care” foster payments. Thus, taxpayers can exclude these payments from their gross income.

Gross Income vs. Earned Income

In the 2019 Tax Court case of Feigh 152 TC No.15, the taxpayer excluded Medicaid waiver payments from taxable gross income and included the payments in earned income for purposes of claiming the earned income credit and additional child tax credit. The IRS denied the credits, arguing that only gross income can be earned income. The Tax Court sided with the taxpayer, ruling that excluding these payments from earned income improperly denies the taxpayer earned income credits and child tax credits.

No Deference for Notice 2014-7

The court concluded that Notice 2014-7 does not entitle any deference of interpretation for two reasons:

  1. The Medicaid payments received by the taxpayer did not satisfy the plain statutory definition of excludable foster care payments covered by IRC Section 131 and referenced in Notice 2014-7.
  2. An IRS notice cannot remove a statutory benefit authorized by Congress.

The Medicaid waiver payments were not covered by IRC Section 131 and they absolutely fall within the statutory definition of “earned income.” The IRS could not rely on Notice 2014-7 to deny credits that Congress clearly intended to provide for earned income.

IRS, Not Congress, Provided Double Benefit

Finally, the court recognized that the taxpayers were receiving an unintended double benefit, because they were getting tax credits that were based on tax-free income. However, this double benefit was created by the IRS who:

  1. Unilaterally decided to exclude Medicaid waiver payments from gross income, and
  2. failed to prove that such payments are not includible in earned income by statute.

For more information about this article, please contact our tax professionals at taxalerts@windes.com or toll free at 844.4WINDES (844.494.6337).

 

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