When an adult child or other family member provides significant services to care for an aging parent, they may decide to enter into a caregiver agreement. The parent decides to compensate the child or other family member, who may be sacrificing other income-producing opportunities in order to provide the care.
As pointed out by the Law Firm of Martin J. Hagan, all the terms of a caregiver agreement should be clearly indicated in writing. This agreement may be reviewed by other family members, the Department of Public Welfare for a Medicaid application, and the IRS. The agreement should include a detailed description of the services to be provided, and the amount of compensation to be paid.
Reasonable compensation could be based on what home-care agencies or other independent care givers charge for similar services. How the compensation will be paid should also be indicated, whether a fixed amount per period, such as weekly, bi-weekly, or monthly, or based on hours. The payment could also be a lump sum amount.
As indicated by Linda Fodrini-Johnson, MA, MFT, CMC in an article for the National Association of Professional Geriatric Care Managers, for purposes of transparency, a sibling of the care provider, or a professional fiduciary could write the checks to pay for the services. If the caregiver writes the checks, he or she should be accountable to a trustee, attorney, or to the family.
Attorney John L. Roberts points out the importance of a detailed contract if nursing home care is needed in the future. He cites a court case in which Medicaid considered a lump sum payment under a caregiver agreement to be a disqualifying transfer. The money had to be paid back and payment had to be made for the nursing home care. The court’s decision was based on the fact that the agreement did not specify the hours of service to be provided and there was no way to determine the fair market value of the services. But when a caregiver agreement is accepted by Medicaid, the payments made by the parent can reduce the amount in the estate and allow eligibility for long term Medicaid coverage in a nursing home.
In terms of income tax, since the adult child or other family member is providing services for compensation, the caregiver agreement results in taxable income. The family member providing the services would generally report the income on Schedule C or Schedule C-EZ. The compensation received for the services performed would also be subject to social security and Medicare taxes. If payment for the services is not done through a payroll system, with federal and state income taxes and social security and Medicare taxes withheld, the family member who provides the services would be subject to self-employment tax, which is calculated on Schedule SE.
Martin J. Hagan explains that if payment for the caregiver services is made as a lump sum, it may be decided to transfer the funds to a third-party escrow agent who would pay the caregiver in installments. Under this method, if the caregiver is on a cash basis for tax purposes, the income would be reported when it is actually or constructively received.
But if the agreement specifies that the caregiver will ultimately receive the entire lump sum, the caregiver would have to recognize the total amount as income when it is placed in escrow. To avoid this, the agreement would have to specify that payments are not made from the escrow account until earned, and any amount remaining in the escrow account when the agreement terminates would go to the parent’s estate. But this could potentially result in the application of the Medicaid estate recovery rules if the parent claims Medicaid coverage for nursing home care.
Dale Krause of Krause Financial Services points out the possibility of transferring a lump sum payment to an escrow agent by purchasing an immediate annuity. The parent would transfer ownership of the annuity to the escrow agent. Guaranteed periodic payments would be made to the caregiver and the escrow agent would change the payee of the periodic payments to the caregiver according to the caregiver agreement. In this case, payments would be taxable income to the caregiver as they are received. Krause indicates that this planning technique depends on each state’s laws regarding caregiver agreements and transfers of assets.
In terms of a tax deduction for medical expenses, according to the IRS the parent could normally claim the cost of long-term care services if the he or she is chronically ill and the services are provided pursuant to a plan of care prescribed by a doctor. But as pointed out by Martin J. Hagan, the deduction is not allowed if the services are provided by parent’s spouse, lineal descendant, brother or sister.
Sources:
Attorney John L. Roberts, Caregiver Contracts that Protect Elders, and Their Family Members, Law Office of John L. Roberts
Caregiver Agreement, Law Firm of Martin J. Hagan, LLC
The Federal Income Tax Consequences of Funding a Caregiver Agreement with an Immediate Annuity, Krause Financial Services
Linda Fodrini-Johnson, MA, MFT, CMC, Family Caregiver Agreements, National Association of Professional Geriatric Care Managers
Publication 502, Medical and Dental Expenses, IRS
Schedule C, Profit or Loss from Business, IRS
Schedule C-EZ, Net Profit from Business, IRS
Schedule SE, Self-Employment Tax, IRS