I should start by mentioning that our firm does not give income tax advice. We are not CPAs or tax attorneys, and we defer to tax specialists on all income tax (or any tax) related matter.
Personal Services Contracts, a/k/a Family Medicaid Caregiver Agreement, are one of many potential Medicaid planning techniques your elder law attorney may advise as a way to protect a Medicaid-applicant’s resources. The link above dives deeper into explaining family caregiver agreements (a/k/a personal services contracts). In essence, Florida law allows any caregiver, even a family member or close friend, to be paid for the services that they render on behalf of another. Even though adult children do not generally charge for providing services to their elderly parent, there is no law requiring that friend and family only be paid in love. So, if your elder care attorney can legally and ethically transfer some money out of the Medicaid-applicant’s name and into the name of their children for services that they are going to render anyway, so that all of the Medicaid-applicant’s money doesn’t have to go toward their cost of care, this is a win-win, right? In the long run, undoubtedly yes.
But, enter the tax man.
Do I have to pay income taxes on a personal services contract?
To the IRS, income is income, regardless of the source – and they want the income tax they are owed. If you are on the receiving end of a valid personal-services contract or family caregiver agreement – i.e. you are getting paid for providing care to a loved one who is receiving or applying for Medicaid waiver or institutional long-term care benefits, tax professionals mostly seem to agree, that this would be income to the caregiver.
As a side note, I have heard some tax attorneys argue that money received per a family caregiver contract is not income, but most do not hold that position (again, we defer to your tax adviser).
It can then be quite the shock when, at the end of the year, their tax preparer explains to the care provider that they have to give 1/3rd (or whatever the tax bracket dictates), of what they received from a personal services contract, to the IRS. Since your elder law attorney is often transferring large chunks of money through the caregiver contract, the tax hit can be an unwelcome surprise.
What Does the IRS say about Family Caregivers?
Special rules apply to workers who perform in-home services for elderly or disabled individuals (caregivers). Caregivers are typically employees of the individuals for whom they provide services because they work in the homes of the elderly or disabled individuals and these individuals have the right to tell the caregivers what needs to be done. These services may or may not be provided by a family member. If the caregiver employee is a family member, the employer may not owe employment taxes even though the employer needs to report the caregiver's compensation on a Form W-2. See Publication 926, Household Employer's Tax Guide for more information.
However, in some cases the caregivers are not employees. In such cases, the caregiver must still report the compensation as income of his or her Form 1040, and may be required to pay self-employment tax depending on the facts and circumstances.
Read more directly at IRS.gov here: Family Caregivers and Self Employment Taxes
Can Income Taxes Owed on a Family Caregiver Agreement Be Deferred?
Yes. A really useful strategy to spread a personal care contract’s income-tax burden over a period of years is to place the care provider’s compensation into an immediate annuity that pays out over time. Utilizing the strategy allows the caregiver to only pays taxes as income is received from the annuity, not in one large lump sum.
Remember that the primary goal is to qualify someone for medicaid which involves getting resources out of their name in a medicaid-compliant manner. So, while a care receiver could pay their care provider as services are rendered, that would not be efficient for medicaid-planning purposes. Your elder law attorney, typically, wants to get as much money out of the medicaid applicant's name as possible using a variety of techniques (one of which may be the personal services contract). This is why the annuity is needed - it achieves the goal of getting a large lump sum out of the medicaid applicant's name but spreads out the income to the caregiver over a period of years.
Another risk of giving the money to a caregiver in one large lump sum through a valid personal services contract is that the money does, in fact, become 100% the caregiver’s. If they want to run to Vegas and put it all on red, they can legally do so. So, in addition to spreading out the income tax burden, utilizing a Medicaid compliant annuity to fund a personal services contract, adds an additional layer of security for the Medicaid recipient - knowing that the money will be doled out over a period of years rather than immediately.