Couple Could Claim Credits Based on Medicaid Waiver Payment Excluded from Income

(Parker Tax Publishing May 2019)

The Tax Court held that a taxpayer who received a Medicaid waiver payment pursuant to a state Medicaid waiver program for the care of the taxpayer's disabled adult children was entitled to claim an earned income tax credit and the refundable portion of a child tax credit, even though the credits are calculated with respect to "earned income" and the IRS excluded Medicaid waiver payments from gross income in Notice 2014-7. The Tax Court held that the Medicaid waiver payment did not fall under the plain text of Code Sec. 131, which excludes qualified foster care payments, and Notice 2014-7 could not reclassify the Medicaid waiver payment to remove a statutory benefit. Feigh v. Comm'r, 152 T.C. No. 15 (2019).

Background

Mary Feigh was issued a Form W-2 for 2015 reflecting $7,353 in wages resulting from a Medicaid payment for the care of her and her husband's disabled adult children. The Feighs reported the payment on their 2015 Form 1040. They had no other Form W-2 income for 2015.

Observation: A Medicaid waiver payment is a payment received by an individual care provider as part of a state's Medicaid Home and Community-Based Services Waiver Program under Sec. 1915(c) of the Social Security Act.

Although the Feighs reported their Medicaid waiver payment on their 2015 tax return, they excluded the payment from their calculation of gross income pursuant to the instructions included with Form 1040. The Feighs claimed an earned income tax credit (EITC) of $3,319 and an additional child tax credit (ACTC) of $653, which represented the refundable portion of their child tax credit. The IRS disallowed the Feighs' claimed EITC and ACTC, and the Feighs petitioned the Tax Court to challenge the IRS's determination.

Code Sec. 131 excludes from gross income qualified foster care payments, which are defined as payments made pursuant to a foster care program and which are "difficulty of care payments." A difficulty of care payment is defined in Code Sec. 131(c) as compensation for caring for an individual who is living in a foster family home and who was placed there by a state agency. In Notice 2014-7, the IRS said that in order to achieve consistent federal tax treatment of Medicaid waiver payments, such payments would be treated as difficulty of care payments that are excludable in Code Sec. 131, and this treatment would apply whether the care provider is related or unrelated to the eligible individual.

To qualify for an EITC or an ACTC, the Feighs had to demonstrate that they had earned income for 2015 as that term is defined in Code Sec. 32. The IRS argued that the Medicaid waiver payment was excluded from gross income pursuant to Notice 2014-7 and thus did not qualify as earned income for the purpose of determining EITC and ACTC eligibility. According to the IRS, Congress did not intend to allow the Feighs the double benefit of excluding their payment from gross income and receiving credits with respect to it. The Feighs countered that there was no statutory, regulatory, or judicial authority that classifies Medicaid waiver payments as not includible in gross income. Rather, the sole authority for this classification is Notice 2014-7. The Feighs argued that the IRS could not, through a subregulatory notice, reclassify their otherwise earned income as unearned for purposes of determining tax credit eligibility.

Analysis

The Tax Court held that the Feighs' Medicaid waiver payment did not fall under the plain text of Code Sec. 131 and that Notice 2014-7 could not reclassify their Medicaid waiver payment to remove a statutory benefit. The court found that the plain text of Code Sec. 131 rendered it inapplicable to the care of biological adult children. The court further found that the statute, which requires that the care recipient be placed in a foster family home, did not apply in this case, where the Feighs were caring for their related adult children in their own home. The court therefore concluded that the Feighs' Medicaid waiver payment did not fall under the plain text of Code Sec. 131, and turned to Notice 2014-7 to examine its ability to classify the income as such.

The Tax Court said the issue was whether the IRS could usurp Congress' authority by denying a credit to which the taxpayers would otherwise be entitled. The court found that Notice 2014-7 was entitled to little, if any, deference because the Feighs' Medicaid waiver payment did not fit the plain statutory definition of a qualified foster care payment in Code Sec. 131. The court also found that the IRS was not authorized to remove a statutory benefit provided by Congress, which it found was exactly what the IRS was seeking to do in this case.

The court responded to the IRS's double benefit argument by pointing out that it was the IRS, not Congress, providing a double benefit. The court reasoned that without Notice 2014-7, Code Sec. 32 would allow the Feighs the benefits of earned income for their Medicaid waiver payment but that payment would remain subject to tax under Code Sec. 61. In the court's view, the IRS decided to disturb this equilibrium by telling taxpayers like the Feighs that they need not pay tax on their Medicaid waiver payments. The court concluded that where income does not fall within the plain text of a statutory exclusion from gross income, the IRS cannot reclassify that income through a notice so that it no longer qualifies as earned income for the purpose of determining tax credits.

For a discussion of the exclusion from income of foster care payments, see Parker Tax ¶78,501. For a discussion of the earned income credit, see Parker Tax ¶102,100. For a discussion of the refundable portion of the child tax credit, see Parker Tax ¶100,715.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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