Medicaid waiver tax exclusion rules for caregiver clients

At tax time, your caregiver clients may bring you:

• Forms W-2, Wage and Tax Statement, with payments in Box 1
• W-2s with Box 12, Code II
• Forms 1099-NEC, Nonemployee Compensation
• Forms 1099-MISC, Miscellaneous Information, or
• No income form at all

Since the forms themselves will not reveal income-exclusion eligibility, the key questions are whether the payments were made:

1. Under an eligible Medicaid program
2. For qualifying care
3. Provided in the caregiver’s home, and
4. Whether the taxpayer should count the payments as earned income for the earned income credit (EIC) and additional child tax credit (ACTC)

Notice 2014-7 has applied to payments received since Jan. 3, 2014. The IRS page was last reviewed or updated April 29, 2026. Its guidance addresses Form W-2, Box 12, Code II and the Medicaid waiver payment entry on Schedule 1 (Form 1040), Additional Income and Adjustments to Income, Line 8s.

Home is where the exclusion is

Notice 2014-7 treats qualifying Medicaid waiver payments as difficulty-of-care payments excludable from gross income under §131. The payments generally must be made under a state Medicaid Home and Community-Based Services waiver program for care provided under the recipient’s plan of care while the recipient lives in the provider’s home. The provider and recipient may be related or unrelated.

The provider’s home must be where the provider resides and regularly conducts private life. It is not simply a place where the provider sleeps while working.

• A provider who moves into a parent’s home and maintains no separate residence may qualify.
• A provider who stays with a recipient during the workweek but returns to a separate family home generally does not.

Separate qualifying program payments from other compensation. Direct private-pay amounts, vacation pay, reimbursements and payments for services performed outside the shared home do not qualify merely because the taxpayer also receives Medicaid waiver payments.

Give each payment the right tax home

For a Form W-2, begin with the boxes. Nontaxable Medicaid waiver payments may appear in Box 12 with Code II instead of in Box 1.

If qualifying payments are included in Box 1, follow the current instructions for Form 1040, U.S. Individual Income Tax Return, and enter the nontaxable amount as a negative number on Schedule 1, Line 8s. If Box 1 is blank or zero and the taxpayer does not elect to count Code II payments as earned income, the W-2 amount does not need to be reported on the return. If the taxpayer makes the election, report the Code II amount on Form 1040, Line 1d, and enter the nontaxable amount as a negative number on Schedule 1, Line 8s.

A Form 1099-NEC or Form 1099-MISC requires another determination: Does the taxpayer operate a separate trade or business providing home-care services?

If there is no separate business, report the payment on Form 1040, Line 1d, and subtract the nontaxable amount on Schedule 1, Line 8s.

If the taxpayer operates a home-care business as a sole proprietor, report the full amount on Schedule C (Form 1040), Profit or Loss From Business (Sole Proprietorship). Enter the excludable amount in Part V as an other expense labeled “Notice 2014-7.” The excluded amount is not subject to self-employment tax.

Analyze employment taxes separately. The income-tax exclusion does not determine FICA treatment, which depends on who employs the provider and whether a domestic-service exception applies.

Tax-free payments can still earn credit

A taxpayer may choose to count qualifying Medicaid waiver payments as earned income for the EIC and ACTC if the payments otherwise constitute wages or self-employment income.

The choice applies to all or none of that taxpayer’s qualifying payments for the year. On a joint return, each spouse who received qualifying payments may make a separate all-or-none choice.

Run the return both ways. Counting the payments may increase a credit, reduce it because of a phaseout or produce no benefit.

Review open years when qualifying payments were incorrectly taxed or when counting them as earned income could have increased the taxpayer’s EIC or ACTC. An open year return may need to be amended.

Your Medicaid waiver payment care plan

Before completing the return:

• Identify the state Medicaid program and payer.
• Confirm the services were covered by the recipient’s plan of care.
• Document that the recipient lived in the provider’s actual home.
• Separate qualifying program payments from private pay, vacation pay, reimbursements and unrelated wages.
• Match the reporting path to the form the client received.
• Calculate the EIC and ACTC with and without the qualifying payments.
• Analyze FICA or self-employment tax separately.
• Check whether the state follows federal treatment.

Do not let the information return make the tax decision for you. Qualify the payment, follow the reporting path and test the credit result. When caregiver income gets complicated, NATP helps you care for every detail.