Quick Answer
Yes — but only for specific purposes. Difficulty of care payments (also called Medicaid waiver payments) are generally excluded from your taxable income under IRS Notice 2014-7 when you care for someone who lives with you under a state Medicaid home and community-based services (HCBS) waiver. At the same time, you may elect to treat those same payments as earned income when figuring the Earned Income Tax Credit (EITC) and the Additional Child Tax Credit (ACTC) — and, since the SECURE Act, they count as compensation for IRA contribution purposes. So the honest answer is: excluded from gross income, yet optionally counted as earned income where the tax law says so. Whether the election helps you depends on your whole return, so always run the numbers both ways before you file.
What Are Difficulty of Care Payments?
Difficulty of care payments are amounts paid to a caregiver for providing non-medical care to an eligible individual in the caregiver’s own home, under a state Medicaid HCBS waiver program (or a similar state program). The person receiving care is usually a family member — a child or adult with a disability — who would otherwise need institutional care.
The care itself is everyday support, not medical treatment: help with bathing, dressing, eating, mobility, supervision, and household tasks that keep the person safely at home. The payer is typically the state or an agency acting for the state, and the caregiver often receives a W-2 for the payments.
Three conditions drive almost every tax question about these payments:
- The care is provided under a qualifying Medicaid waiver or similar program.
- The care recipient lives in the caregiver’s home — this is the make-or-break test for the income exclusion.
- The services are non-medical personal care, not skilled nursing or medical treatment.
If the recipient does not live with you, the exclusion generally does not apply, and the payments are taxable like other wages. That single fact — same household or not — changes everything that follows.
The Core Rule: IRS Notice 2014-7
IRS Notice 2014-7 is the document that created the modern treatment. It says that difficulty of care payments received by a caregiver who lives with the care recipient are excludable from gross income. In plain terms: you do not pay federal income tax on them, and they do not add to your adjusted gross income (AGI).
Why does that matter beyond the tax bill itself? Because AGI drives so many other things — eligibility for income-based credits, the size of certain deductions, and even state benefit calculations. Excluding a large block of income can lower your AGI substantially, which is usually good news.
But there is a catch built into the same rule. Because the payments are excluded, they are not automatically “earned income” for every purpose. The IRS solved part of that problem by letting you elect to count them as earned income for the EITC and ACTC. That election is optional, year by year, and it is the part most caregivers — and most tax software — get wrong.
How to Tell If Your W-2 Qualifies
Not every caregiving paycheck is a difficulty of care payment. Look for these signs on your W-2:
- Box 1 (wages) may show the payments, but Box 3 (Social Security wages) and Box 5 (Medicare wages) are often $0 or much lower. That pattern signals the payer treated the amounts as non-FICA wages, consistent with difficulty of care treatment.
- Box 14 may carry a note such as “Medicaid Waiver,” “Difficulty of Care,” or “Excludable income.” Box 14 notes are informational, not a guarantee, but they are a strong hint.
- You live with the person you care for. If you do not, stop here — the Notice 2014-7 exclusion almost certainly does not apply to you, and you should get professional advice before excluding anything.
If your W-2 looks different — for example, full Social Security and Medicare wages with no Box 14 note — your payer may be treating the payments as ordinary taxable wages. Do not assume the exclusion applies just because the work is caregiving.
Are Difficulty of Care Payments Considered Earned Income? Purpose by Purpose
This is where most short articles fail: they give one answer when the tax law gives several. The table below is the whole story in one place.
| Purpose | Counted as earned income? |
|---|---|
| Federal income tax (gross income) | No — excluded under Notice 2014-7 if you live with the recipient; lowers taxable income and AGI. |
| Earned Income Tax Credit (EITC) | Yes, IF you elect to include them; election can increase or decrease your credit. |
| Additional Child Tax Credit (ACTC) | Yes, IF you elect to include them; same election as the EITC, you cannot split it. |
| IRA / Roth IRA contributions | Yes — treated as compensation under the SECURE Act; lets caregivers save for retirement despite the exclusion. |
| Social Security benefits and earnings test | Generally no — not counted as earnings from work for benefit purposes; receiving them should not reduce Social Security benefits on earnings grounds. |
| State income tax | Depends on the state; some states follow the federal exclusion, others had to clarify it separately. |
Read that table twice before you file. The most expensive mistake is assuming one row applies to every other row.
For the Earned Income Tax Credit: The Election That Changes Everything
Here is the situation the election was designed to fix. A caregiver who excludes all difficulty of care payments might end up with little or no “earned income” on paper. With no earned income, there is no EITC — even though the caregiver plainly worked for the money. Congress and the IRS fixed this by allowing an election: you may choose to treat the excluded payments as earned income solely for computing the EITC and ACTC.
The election is not automatically good for you. Consider both directions:
| Situation | If you elect | If you do not elect |
|---|---|---|
| You have little other earned income | Electing can create or increase an EITC you would otherwise miss | Not electing may leave the EITC at $0 |
| You already qualify for a large EITC | Electing may increase the credit up to the phase-out range | Not electing keeps the credit as calculated on other income |
| Your income is near the EITC phase-out | Extra “earned income” can push you past the limit and shrink the credit | Not electing protects the credit from phase-out |
| You claim the ACTC | Same inclusion applies — the election covers both credits together | Not electing means the ACTC is calculated without the payments |
The practical rule used by careful preparers: calculate your return both ways and file the version that gives the better overall result. Tax software usually has a specific entry for Medicaid waiver payments or Notice 2014-7 income — use it, rather than typing the amount in as ordinary wages, so the exclusion and the election are handled correctly.
For IRA Contributions: The SECURE Act Fix
Before the SECURE Act, the exclusion created a second trap. A caregiver with only excluded income had no “compensation” to support an IRA contribution — the very exclusion that saved income tax also blocked retirement saving. The SECURE Act fixed this: tax-exempt difficulty of care payments now count as compensation for IRA purposes. That means you can contribute to a traditional or Roth IRA based on those payments, up to the usual annual limits, even though the income itself is not taxed.
This is a genuinely valuable planning point that many short guides omit. If you are a full-time family caregiver, an IRA contribution based on difficulty of care payments may be your only retirement-saving route in a given year — do not leave it on the table by assuming “excluded income means no IRA.”
For Social Security: A Different Answer Again
Difficulty of care payments are generally not treated as earnings for Social Security benefit purposes. In practice, that means receiving them does not reduce Social Security benefits under the earnings test the way ordinary wages would. This matters most for caregivers who also receive Social Security Disability Insurance (SSDI), Supplemental Security Income (SSI), or early retirement benefits — but the Social Security Administration has its own reporting rules, which do not always mirror IRS rules. If you receive Social Security benefits, confirm the treatment with the SSA or a benefits adviser before relying on the IRS answer alone.
For State Taxes: Do Not Assume Your State Follows the Federal Rule
States have not all moved in lockstep. New Jersey is the cautionary tale: its Division of Taxation changed position more than once in early 2025 before finally confirming that difficulty of care payments qualify as earned income for New Jersey’s EITC, even though they are not taxable wages for state gross income tax purposes. Other states have issued their own clarifications, and some state forms did not mention these payments at all until recently. Always check your state’s current-year instructions — and if you paid state tax on these payments in a year when they should have been excluded, an amended return may recover it, subject to the state’s amendment deadline (often three years from filing).
Step by Step: How to Report Difficulty of Care Payments
Follow these steps in order, and keep your W-2 and any waiver-program paperwork with your return records.
- Confirm you qualify. You live with the care recipient, the care is under a Medicaid HCBS waiver or similar program, and the services are non-medical.
- Check your W-2. Note Box 1, Box 3, Box 5, and any Box 14 Medicaid waiver notation.
- Enter the payments in your tax software’s Medicaid waiver / Notice 2014-7 section — not as ordinary wages. The software should exclude them from taxable income.
- Run the return twice: once with the EITC/ACTC election on, once with it off. Compare the total refund or amount owed, not just the EITC line.
- Check the IRA angle. If you want to contribute, confirm the contribution amount against your difficulty of care payments and the annual IRA limit.
- Check your state return separately. Confirm whether your state excludes the payments and how it treats them for any state EITC.
- If you receive Social Security benefits, verify SSA reporting separately — do not assume the IRS treatment carries over automatically.
If any step contradicts what your software shows — for example, the software taxes the full amount despite a Box 14 waiver note — stop and get a preparer who knows Notice 2014-7. Fixing this after filing means an amended return.
Common Mistakes That Cost Caregivers Money
- Reporting the payments as ordinary wages. This forfeits the exclusion entirely and inflates AGI.
- Excluding the payments but never making the EITC election. This can leave a refundable credit unclaimed.
- Making the election without checking the phase-out. More “earned income” is not always better; near the phase-out it can shrink the credit.
- Assuming the exclusion applies when you do not live with the recipient. It generally does not — and excluding taxable wages invites an IRS notice.
- Ignoring the IRA opportunity. Excluded income can still fund retirement saving under the SECURE Act.
- Assuming your state follows the federal rule. State treatment has varied and changed, sometimes within a single filing season.
- Forgetting prior years. If you overpaid in an earlier year because the exclusion or election was mishandled, an amended return may still be open — check the deadline before it closes.
What If You Already Filed It Wrong?
You are not stuck. If you included payments that should have been excluded, or missed the EITC election, you can generally file an amended return (Form 1040-X) for that year, within the usual amendment window — generally three years from the original filing date or two years from when the tax was paid, whichever is later. State amendment deadlines differ, so check yours. Keep the W-2, waiver documentation, and a note explaining the Notice 2014-7 treatment with the amendment. Many caregivers recover thousands of dollars this way, which is exactly why getting the first filing right matters so much.
Frequently Asked Questions
Are difficulty of care payments taxable?
Generally no, if you live with the care recipient and the payments are made under a qualifying Medicaid waiver program — IRS Notice 2014-7 excludes them from gross income. If you do not live with the recipient, they are generally taxable.
Do difficulty of care payments count as earned income for the EITC?
They can, but only if you elect to treat them as earned income for that purpose. The election is optional and applies to both the EITC and the Additional Child Tax Credit. Run your return both ways and use the better result.
Can I contribute to an IRA with difficulty of care payments?
Yes. Under the SECURE Act, tax-exempt difficulty of care payments count as compensation for IRA contribution purposes, even though they are excluded from taxable income.
Do difficulty of care payments affect Social Security benefits?
Generally they are not counted as earnings for Social Security benefit purposes, so they should not reduce benefits under the earnings test. SSA reporting rules are separate from IRS rules, so confirm your situation if you receive benefits.
What is IRS Notice 2014-7?
It is the IRS guidance that lets caregivers who live with the person they care for exclude Medicaid waiver (difficulty of care) payments from gross income, while still allowing an election to count those payments as earned income for the EITC and ACTC.
Are difficulty of care payments the same as Medicaid waiver payments?
Yes — the two terms describe the same payments. “Medicaid waiver payments” is the program name; “difficulty of care payments” is the tax term used in IRS Notice 2014-7.
Do I need to live with the person I care for to exclude the payments?
Yes, in general. Living in the same home is a core requirement of the Notice 2014-7 exclusion. Caregivers who live elsewhere usually cannot exclude the payments.
The Bottom Line
Are difficulty of care payments considered earned income? For the EITC, the ACTC, and IRA contributions — yes, by election or by statute. For federal taxable income — no, they are excluded. For Social Security — generally no. The caregivers who come out best are the ones who refuse the one-word answer, check their W-2, run the return both ways, and confirm their state’s current position. The money at stake — the exclusion itself, a refundable credit, and a year of retirement saving — is far too large to leave to a guess.
This article is general information, not tax advice. Difficulty of care rules turn on your program, your household, and your state’s current guidance — talk to a qualified tax professional before filing.
