IRS changes position on foster care payments despite court win

The U.S. District Court for the Southern District of Ohio held that payments received by a legal guardian to care for her handicapped adult son could not be excluded from income as qualified foster care payments under Sec. 131. According to the court, a foster care relationship did not exist because the taxpayer, as her son’s guardian, had a legal duty to care for her son.

In a separate development three days before the court’s opinion, however, the IRS reversed its traditional position when it issued a notice allowing an exclusion for foster care payments from similar programs to care providers related to the qualified foster care individual.

Sec. 131 allows an exclusion for payments received by foster care providers from a state’s (or a political subdivision’s) foster care program to care for foster care individuals placed in their home by an agency of the state (or a political subdivision) or an agency licensed or certified by the state (or a political subdivision). Payments received to provide additional care in the foster care provider’s home because the foster care individual has a physical, mental, or emotional handicap, defined as difficulty-of-care payments, can also be excluded. The difficulty-of-care exclusion is limited to payments for 10 qualified foster care individuals under the age of 19 or five individuals age 19 or older per foster home.

Robert and Elaina Ray, residents of New Albany, Ohio, had provided 24-hour care for their 30-year-old severely handicapped son since he was placed in the taxpayers’ home by the Board of Developmental Disabilities for Franklin County of Ohio. Elaina Ray was certified by the state of Ohio as a “certified home and community based waiver or supported living provider” and had been her son’s legal guardian since he turned 18. To compensate her for the care she provided, Elaina received payments from the state of Ohio, funded by a Medicaid program that allows individuals to live at home or in community-based living rather than be institutionalized. After initially including the payments as income on their income tax returns for 2005 through 2007, the taxpayers filed amended returns for those years that excluded the payments. The resulting refund requests for 2006 and 2007 were denied, and the taxpayers appealed. After their appeal was denied, they filed suit for a refund in the district court.

According to the court, the Sec. 131 exclusion requires a foster care relationship characterized by “the absence of an existing legal duty to provide care to that individual.” The court held that, although Elaina had no legal obligation to be her son’s guardian once he reached age 18, once she became his guardian, she had a legal duty to care for him; therefore, the care provided by her was not foster care, and the payments could not be excluded under Sec. 131.

However, in Notice 2014-7, the IRS revised its position on this issue and announced that it will treat qualified Medicaid waiver payments as difficulty-of-care payments that are excludable under Sec. 131, regardless of whether the care provider is related to the eligible individual. Qualified Medicaid waiver payments are defined as “payments made by a state or political subdivision thereof, or an entity that is a certified Medicaid provider, under a Medicaid waiver program to an individual care provider for nonmedical support services provided under a plan of care to an eligible individual (whether related or unrelated) living in the individual care provider’s home.” The new guidance is effective for payments received on or after Jan. 3, 2014. Taxpayers may also use this guidance for tax years still open under the normal statute of limitation period.

It was not immediately clear whether the IRS’s changed stance would have applied to the Rays’ facts and circumstances if effective then or applies to the same program currently. The district court noted in a footnote that the Ohio program changed its guidelines in 2007 to define “adult foster care” services as those provided to an adult by a caregiver who is not related to the individual receiving the services.

  Ray, No. 2:12-cv-677 (S.D. Ohio 1/6/14)

  Notice 2014-7

By Charles J. Reichert, CPA, instructor of accounting, University of Minnesota–Duluth.