INTRODUCTION
A caregiver agreement is a written contract entered into by an older person, who needs assistance with their personal care and daily household activities, and a caregiver, usually an adult child or other family member, in which the caregiver agrees to provide 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 forms of 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.
CONTENTS
■ Advantages of the Caregiver Agreement in Long-Term Care
■ Elements of a Caregiver Agreement
■ Tax Treatment of Caregiver Agreements
■ ADVANTAGES OF THE CAREGIVER AGREEMENT IN LONG-TERM CARE
Advantages for Older Person
For older persons, the primary advantage to having a caregiver agreement in place is that it will secure an arrangement that 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 all payment until death and leaving the child a disproportionately larger share of the estate in their Will. 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 more favorable treatment of the caregiver-child 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 in place is that it will provide a reliable source of income as compensation for their services. This should avoid the resentment that can build up in the caregiver if they are devoting substantial time to such care, perhaps sacrificing other income-earning opportunities, without receiving fair compensation in return.
Medicaid Planning
A caregiver agreement can also be part of a strategy aimed at accelerating Medicaid eligibility for the older person. Payments made under the agreement, if properly structured and reasonable in amount, can be treated as transfers for value rather than as gifts. These payments will reduce the older person’s countable assets, which in turn will accelerate their Medicaid eligibility.
■ ELEMENTS OF A CAREGIVER AGREEMENT
Given that the caregiver agreement will likely be examined critically by several parties, including other family members, the state agency evaluating the older person’s 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 to, let alone whether they ever intended to create a legally binding contract.
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 intake and outtake, 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 acute care (hospital), 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?
Many caregiver agreements seem to take for granted that the caregiver is an independent contractor and not an employee of the older person. Be aware, however, that simply calling the caregiver an “independent contractor” in the agreement will not be decisive. The IRS and other third parties, such as the state unemployment and worker’s compensation offices, may well conclude, after considering all the facts of the parties’ arrangement, that the caregiver is the older person’s employee and 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 by legal counsel will be 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), regardless of the specific number of hours worked within that period, or
✔ An amount to be determined by multiplying an agreed-upon hourly rate by the number of hours worked in a specific time period. In this case, the caregiver should keep and retain detailed time records in anticipation of future requests by third parties for proof that the services were actually performed.
Reasonable Compensation
To defend against a charge 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 here is best determined by comparing what other independent caregivers or home-care agencies are charging 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 most recent Survey reports that for 2023 the hourly rate in the Pittsburgh metropolitan area for both homemaker and home health aide services is $29.71. By comparison, in the Scranton area the hourly rate is $25.46 for both homemaker and home health aide services, and for Philadelphia the hourly rate for homemaker services is $29.65 and home health aides $29.71 per hour.
When using such surveys to discover a locale’s prevailing rates, be sure to use an “apples to apples” approach, i.e., match the particular 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 for homemaker services, which is the job title for someone who provides only basic non-medical housekeeping and companionship services, may well be less than the wages paid to a certified nursing aide who possesses some level of medical training.
To justify a higher wage to be paid to a caregiver, they could complete a nursing aide certification program that are available at many community colleges.
What Will Be the Method and Frequency of Payment?
Payments can be made either in:
✔ Periodic payments (e.g., weekly, bi-weekly, or monthly) during the term of the agreement, or
✔ Lump sum paid at the outset upon execution of the contract. This form of payment will eliminate the risk to the caregiver that the older person may later become incapacitated and thus unable to continue making future installment payments (although a well-drafted Durable Power of Attorney could solve this problem). It is also the payment method to be used if Medicaid eligibility is a planning 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, which under current Social Security Tables means that his life expectancy is 6.44 years, or 77.28 months. Bill 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 77.28 months = $231,840).
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 predicted by the life expectancy tables, he will have paid out more than what would otherwise have been necessary. But it is precisely these mutual risks that make their agreement a binding contract, which in turn establishes that no gift occurred when the lump sum payment of $231,840 was made. A payment made under such a contract should avoid Medicaid’s 5-year look back rule, which by definition applies only to gifts.
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 but not rendering the promised services.
To ensure that that the lump sum will not be exhausted prior to death, the agreement could call for the payments from the escrow account to be adjusted by an annual recalculation of the older person’s life expectancy.
An important issue to be addressed in an escrow arrangement is the disposition of the funds that may still be 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 for Pennsylvania residents 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 remaining at the older person’s death.
When Will the Caregiver Agreement Terminate?
The agreement will typically provide that its terms will end automatically upon the older person’s death, or upon the occurrence of a specific event, such as the older person’s permanent move to a skilled nursing facility. The agreement could also allow either party to terminate it whenever they would choose. In this case, 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, e.g., 30 or 60 days? A number of factors will bear on this issue. Discuss with your attorney what a reasonable time period would be in your particular case.
■ TAX TREATMENT OF CAREGIVER AGREEMENTS
Employee or Independent Contractor?
Based on the nature of the caregiver’s duties performed under the typical caregiver agreement, be aware that the IRS will likely want to classify the caregiver as an employee of the older person, and not an independent contractor. (See IRS Publications 926 and 1779.) This distinction is important, since the older person as an employer will have to obtain an EIN, withhold Social Security and Medicare taxes, and perhaps pay state workers’ compensation and 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, where the reporting and compliance duties are much less onerous, special drafting of the caregiver agreement by legal counsel will be imperative.
Payments Are Taxable Income to Caregiver
Regardless of the caregiver’s legal status in relation to the older person, payments for services rendered will be taxable as earned income, and will have to be reported on the caregiver’s federal, state, and any local earned income tax returns. For each year the caregiver should be given a Form W-2 if deemed an employee, or a Form 1099-MISC if classified as an independent contractor. In addition to federal income taxes, an independent contractor will also be responsible for paying federal self-employment tax.
No “Under the Table” Payments!
While one or both parties may be tempted to have the caregiver paid “under the table” in order to avoid having to report or pay any taxes on the caregiver’s compensation, that would be a 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 may 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 in all cases the caregiver must report the payments received as earned income, the older person may not be able to deduct the same payments on their own federal 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 older person 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.
Constructive Receipt
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 they may draw on it at any time, or could have drawn on 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 as stated above in that case the state 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 in which 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.