Foster Care Payments to Mother Not Excludible from Gross Income.
(Parker Tax Publishing January 2014)

Because a mother was the guardian of her adult handicapped son and owed a legal duty to provide care for him, her provision of care could not be characterized as foster care, and payments she received from the state for providing her son's care were not excludable from gross income as qualified foster care payments. Ray v. U.S., 2014 PTC 4 (S.D. Ohio 1/06/14).

Tony Ray, an adult, lived with his parents, Robert and Elaina. Tony, severely handicapped since birth and diagnosed with several medical conditions, was unable to provide for his own needs and required constant care. When Tony turned age 18, his mother was appointed his legal guardian, and his care was managed by the county board for developmental disabilities. A board-assigned case manager developed an Individualized Service Plan (ISP) for Tony, which set forth the areas of care and support needed, specific descriptions on how the needs would be met, the care provider for each area of need, and the duration for which the need required care. Tony's ISP required that his care be provided by a certified home and community-based waiver or supported living provider. Elaina obtained the required certification through the state (Ohio) and provided for the majority of Tony's needs. Elaina received compensation from the state for the care she provided Tony through a Medicaid program called Individual Options Waiver (IO Waiver), which allows for individuals with developmental disabilities to live at home or in community-based living rather than in an institutional setting.

On their original returns for 2006 and 2007, Robert and Elaina included the Medicaid payments in income. They subsequently filed amended returns for those years and excluded the Medicaid payments from income. The Rays' claims for refunds were denied by the IRS on the basis that the amounts did not meet the requirements for the exclusion.

Code Sec. 131 provides that gross income does not include amounts received by a foster care provider during the tax year as qualified foster care payments. Qualified foster care payments are defined as a payment made by a state, political subdivision thereof, or qualified foster care placement agency under a state foster care program that is either (1) a payment to a foster care provider for caring for a qualified foster care individual in the provider's home; or (2) a difficulty-of-care payment.

The Rays argued that Tony was an adult for whom they had no legal duty to provide care and that their voluntary provision of care was "fostering."

The IRS contended that the ordinary meaning of the term "foster care" concerned the placement of a minor into the care of someone who was not the minor's parent by blood or adoption, and the blood relationship between Elaina and Tony eliminated their care from being a foster care relationship.

A district court held that the terms "foster" and "foster care" required the absence of an existing legal duty to care for an individual receiving care in the taxpayer's home. It was undisputed that the Rays received payments from the state and that Tony was placed in the Rays' home by a state agency. However, the terms "foster" and "foster care" for purposes of the foster care payment exclusion are not defined in Internal Revenue Code.

The court looked to state law, which defined "age of majority" as all persons of the age of 18 or more who are under no legal disability and "legal disability" as persons (1) under the age of 18; (2) of unsound mind; (3) in captivity; or (4) under guardianship of the person and estate. Generally, the legal duty of parental care stops when a child reaches the age of majority. The court noted that Tony, an incompetent due to his legal disability, had not reached the age of majority under state law and could not be described as an adult. Moreover, the Rays presented evidence that Elaina was Tony's guardian since he turned age 18.

In rejecting the Rays' argument that Elaina provided care to an individual where she owed no obligation, the court stated that when Elaina became Tony's legal guardian, state law imposed a duty upon her to provide for him. Therefore, the relationship between Elaina and Tony was not a foster care relationship within the meaning of Code Sec. 131, and the payments she received from the state were not excludable from gross income, the court concluded.

OBSERVATION: This is exactly the type of situation that Notice 2014-7, discussed above, was meant to address. Under Notice 2014-7, the payments to the Rays would have been excludible from income.

For a discussion of the taxation of foster care payments, see Parker Tax ¶78,500. (Staff Contributor Parker Tax Publishing)

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