CAREGIVER AGREEMENTS IN LONG-TERM CARE PLANNING
A caregiver agreement is a written contract entered into by an older person who needs assistance with his or her personal care and daily household activities, and a caregiver (usually an adult child or another family member), in which the caregiver agrees to render personal and home care services, and perhaps a basic level of nursing care, to the older person in exchange for the payment of money or other consideration.
This outline will describe the advantages to both parties in using such an agreement, with a special focus on Medicaid planning. The elements of a well-drafted caregiver agreement will then be discussed, as well as the income tax issues that will arise with the use of such an agreement.
Advantage for Older Person
For older persons, the advantage in having a caregiver agreement in effect is that it will allow them to be cared for at home rather than in an institution. If the caregiver is one of several children of the older person, paying reasonable compensation for the caregiver’s services at the time they are rendered is a better solution than deferring payment until death by leaving the child a disproportionately larger share of the estate. First, there is a risk that the value of the larger share may turn out to be significantly more or less than the reasonable value of the services performed. Second, the favorable treatment of the caregiver in the parent’s Will may lead to accusations by the other children that the caregiver-child took advantage of the parent.
Advantages for Caregiver
For the caregiver, the advantage of having such a contract is that it will provide a reliable source of income as compensation for their services. This should avoid the resentment that can build up when a child is devoting substantial time to such care, perhaps sacrificing other income-earning opportunities, without receiving fair compensation in return.
A caregiver agreement can also be part of a strategy aimed at accelerating Medicaid eligibility for an older person. Payments made under the agreement, if properly structured and reasonable in amount, will be treated as transfers for value, not gifts. These payments will reduce the older person’s countable assets, which in turn will accelerate Medicaid eligibility.
Given that the caregiver agreement will likely be examined critically by several parties, including other family members, the Pennsylvania Department of Public Welfare (“DPW”) in connection with a Medicaid application, and the IRS, it is important that the agreement be drafted in anticipation of the issues that may be raised by these parties.
First, any such agreement should be in writing and signed by the parties before the services are provided.
Do not rely on an oral “understanding” as to the terms of the caregiver relationship, since if challenged it will be difficult to prove what specific terms the parties had agreed on, let alone whether they ever intended to create a legally binding contract in the first place.
The following are the important issues that the caregiver agreement should address and clearly resolve.
What Are the Duties to Be Performed?
Caregiver services could include, at a minimum:
✔ Homemaking duties (meal preparation, household cleaning, laundry),
✔ Transportation to and from doctor and other professional appointments, and
✔ Assisting the older person in performing some or all of the “activities of daily living,” a term that refers to bathing, dressing, eating, toileting, and transferring.
With proper training and certification, the caregiver may also provide medical care to the older person, such as checking vital signs (blood pressure, pulse, temperature, and respiration), assisting with medications and therapeutic exercises, measuring fluid outtake and intake, and caring for a colostomy or catheter.
In addition, the agreement could define what duties the caregiver would perform during a period when the older person is required to reside outside the home in an assisted living, skilled nursing, or other type of medical or nursing care facility.
What Is the Legal Status of the Caregiver: Employee or Independent Contractor?
Be aware that simply referring to the caregiver in the agreement as an “independent contractor” will not by itself decide this issue. The IRS and other third parties, such as the state unemployment and worker’s compensation offices, may consider the caregiver to be the older person’s employee, not an independent contractor, which in turn will trigger several legal and tax reporting requirements. (See the tax section below for more details.)
To secure the caregiver’s status as an independent contractor, special drafting of the caregiver agreement is imperative.
What Is the Amount of Compensation To Be Paid?
Compensation should be clearly defined as either:
✔ A set amount to be paid for all services performed during a specific time period (e.g., a daily, weekly, or monthly wage), or
✔ An amount to be determined by multiplying an agreed-upon hourly rate by the number of hours worked. In this case, the caregiver should keep detailed time records, in anticipation of future requests by third parties for proof of the services rendered.
To defend against a claim that the compensation paid was, at least in part, a disguised gift from the older person to the caregiver, the parties should be prepared to demonstrate that the amount paid was reasonable. Reasonableness is best determined by comparing what other caregivers are charging, or what home-care agencies are paying, for a similar level of service in the same locale.
The Genworth Cost of Care Survey is a comprehensive resource for discovering state-by-state, and even by metropolitan area, the average costs of home health care, including both homemaker services and home health aides. For example, the 2016 Survey reports that in the Pittsburgh metropolitan area the daily rate paid for homemaker services is $141, and for home health aides it is $144.
When doing a comparison, be sure to use an “apples to apples” approach. Match the caregiver’s level of skill and training with the requirements of the jobs whose wages are being used as benchmarks. For example, the wages paid to a home health aide, which is the job title for someone who provides only basic housekeeping and companionship services, will be less than what is paid to a certified nursing aide who possesses some medical training.
To justify a higher wage paid to the caregiver, he or she could complete a nursing aide certification program, which are available at many community colleges and other locations.
What Will be the Method and Frequency of Payment?
Payments can be made either in:
✔ Periodic payments (e.g., weekly, bi-weekly, or monthly), or
✔ Lump sum paid upon the execution of the contract, which is the form of payment often used when Medicaid eligibility is a goal.
Determining Reasonable Lump Sum Amount
An annuity-type model can be used to determine a reasonable amount to be paid in lump sum form, which will remove any gift element from the transaction. The variables for this type of annuity would be: (1) an agreed-upon hourly wage that itself is reasonable under the criteria discussed above, and (2) the life expectancy of the older person based on established actuarial tables.
Example. Bill is 84 years old, so has a life expectancy of 6.6 years, or 79.2 months, based on current Social Security Tables. He enters into a caregiver agreement with his daughter, Sarah, in which she agrees to work as his caregiver for 30 hours per week at $25 per hour, or a monthly wage of $3,000, for the remainder of his life, whenever that event may occur. A reasonable lump sum payment could then be calculated by multiplying the monthly wage by the equivalent number of months in Bill’s life expectancy ($3,000 x 79 months = $237,600).
The risk to Sarah with this arrangement is that if her father lives beyond his life expectancy, the effective hourly wage will be reduced. The risk to Bill (or his estate) is that if he dies sooner than the time indicated by the life expectancy tables, he will have paid out more than what would otherwise have been needed. But it is precisely these mutual risks that give the contract the consideration that is needed to show that no gift occurred when the lump sum payment was made.
To ensure that that the lump sum will not be exhausted prior to death, the agreement could call for the payments to be adjusted by an annual recalculation of older person’s life expectancy.
Escrow of Lump Sum Payment of Compensation
If the lump sum payment method is chosen, it will be safer to have the payment made to an escrow agent, who in turn would agree to hold the money and make payments in installments to the caregiver. This will eliminate the risk of the caregiver receiving full payment directly and then not rendering the services, or of the older person later becoming incapacitated and thus unable to make future payments.
An important issue to be addressed in an escrow arrangement is the disposition of the funds that are still held in escrow at the older person’s death. Under the annuity model discussed above, the caregiver typically will be entitled to receive any balance remaining in the escrow account, rather than the older person’s estate.
From a Medicaid perspective, the repayment of funds held in the escrow account to the older person’s estate will trigger the Medicaid estate recovery rules, which in turn would require the estate to pay over the funds to the Pennsylvania Department of Human Services (“DHS”) as necessary to reimburse the state for all Medicaid payments that would have been paid on behalf of the older person.
Be sure to review the discussion on constructive receipt in the Taxation section below to appreciate the income tax consequences that will flow from how the agreement treats the parties’ respective right to receive the escrow funds at the older person’s death.
When Will the Caregiver Agreement Terminate?
The agreement will typically provide that it will end automatically upon the older person’s death, but also allow either party to terminate it sooner if he or she so elects. In the latter instance, the agreement should clearly spell out what steps a party must take to effect a valid termination.
If notice of termination is required to be given by one party to the other, how far in advance should notice be given before the effective date of termination? A number of factors will bear on this issue. Discuss with your attorney what a reasonable time period would be in your particular case.
Employee or Independent Contractor?
As stated above, based on the nature of the caregiver’s duties performed under the typical caregiver agreement the IRS will want to classify the caregiver as an employee of the older person, not an independent contractor. See IRS Publication 1779 and IRS Publication 926. The distinction is important, since the employer will have to obtain an EIN, and then withhold Social Security and Medicare taxes, and pay unemployment taxes. A payroll service can be used to ensure that these details will be correctly handled.
To secure the caregiver’s status as an independent contractor, special drafting of the caregiver agreement is imperative.
Payments Are Taxable Income to Caregiver
Regardless of the caregiver’s legal status, payments for services rendered will always be taxable as earned income, and will have to be reported on the caregiver’s federal, state, and any local earned income tax returns. The caregiver should be given a Form W-2 if deemed an employee, or a Form 1099-MISC if classified as an independent contractor.
✔ How Not to Handle Compensation
While one or both parties may be tempted to have the caregiver paid “under the table” in order to avoid having to report and pay income tax on the compensation, that would be a very bad decision for several reasons. First, intentionally not reporting earned income goes by another name — tax evasion — which is a crime under federal, state, and local laws. Second, for Medicaid purposes failing to report the payments as earned income will likely be treated as proof that the parties intended the payments to be gifts, not compensation, which will adversely affect the older person’s Medicaid eligibility.
Limitation on Deductibility of Payments
While the caregiver must report the payments received as earned income in all cases, the older person may not be able to deduct the same payments on his or her own income tax returns. Generally payments made for qualified long-term care expenses, including compensation paid to a caregiver, are deductible as a medical expense. However, this deduction for nursing expenses is disallowed if the caregiver is the taxpayer’s spouse, lineal descendant (e.g., a child or grandchild), brother, or sister, unless the caregiver is a licensed professional with respect to the services being provided. See IRC §§ 213(d)(11) and 152(d)(2). Under the Code’s definition of “relative,” payments to a niece, nephew, or cousin of the dependent would be deductible.
Income Tax Treatment of an Escrow Arrangement
As discussed in the prior section, payment for caregiver services can be paid in a lump sum, but held by an escrow agent for distribution to the caregiver as services are performed. The parties should be aware, however, that this arrangement may cause certain unintended tax results.
For income tax purposes, a cash method taxpayer must attribute items of gross income to the taxable year in which they are actually or constructively received. Income not in the taxpayer’s actual possession is deemed to be constructively received if it is set apart for or actually made available to the taxpayer so that he or she may draw upon it at any time, or could have drawn upon it during the taxable year if notice of intention to withdraw had been given. See Treasury Reg. § 1.451-2 (a).
As applied to a caregiver agreement, constructive receipt analysis would look first to see which party may be ultimately entitled to the balance in the escrow account at the older person’s death. In designing the agreement, the older person’s estate is not a good choice to receive the unearned portion of the escrow fund, since in that case the state Department of Human Services, which handles Medicaid, will have first priority to claim the escrow account balance under the Medicaid estate recovery program. On the other hand, simply providing that the caregiver will be entitled to the death-time balance may cause the caregiver to be deemed in constructive receipt of the entire lump sum in the year the escrow account is initially funded, so that the caregiver would have to pay income tax on the full amount in that year, before any compensation has actually been paid.
Consult with your attorney as to how the caregiver agreement can be drafted to avoid both of these potential pitfalls.