Rev. Rul. 77-280

Advice has been requested as to the Federal income tax consequences and the Federal employment or self-employment tax consequences arising from various arrangements under which individuals provide foster care to children who are deprived of parental care.

Situation 1. A married couple, desiring to provide the advantages of home life to a child deprived of parental care, opened their home to such a child under the supervision of a child-placing agency, a private organization described in section 170(c) of the Internal Revenue Code of 1954. The agency rather than the couple designated the child to be taken into their home. Because they could not afford to provide the entire support of the child, they received funds from the child-placing agency to cover the cost, in whole or in part, of maintaining the child in their home.

The child-placing agency makes a specified payment at the end of the month as reimbursement for amounts expended by the foster parents in providing food, shelter, school supplies, and other items of support for the child during the preceding month. The foster child assists in such household chores as are normally expected of children in a family, but does not render such household services as would compensate the foster parents for their support. The foster parents report to the child-placing agency the amounts paid or incurred for clothing and medical expenses, and the agency makes direct payment to the vendor or physician (if the goods or services were supplied on credit) or increases the monthly check to the foster parents if they have expended their own funds. Periodic inspections are made to insure that the child is receiving adequate care and, if not, the foster parents are relieved of the child's care and custody. The payments made by the child-placing agency to the foster parents are solely for the purpose of reimbursing them for their expenses incurred in taking care of the child placed in their home, and such payments are not in excess of the expenses incurred.

Situation 2. A married couple was licensed by the local department of welfare to provide foster care on a temporary basis to children who are deprived of parental care. Pursuant to the laws and regulations under which the foster care program is administered, the foster parents care for foster children in their home and provide those items necessary and appropriate to the child, including room, board, clothing, personal needs (such as haircuts, toilet articles, school supplies and dues), and spending money. The department of welfare rather than the couple designate the children to be taken into their home. The foster children assist in such household chores as are normally expected of children in a family, but do not render such household services as would compensate the foster parents for their support. The welfare department inspects the foster home periodically to insure that children it has placed there receive proper care, and gives counsel and supervision to the foster parents as needed. If a foster child is not receiving proper care, the child is removed from the care and custody of the foster parents.

The welfare department pays the foster parents at a monthly rate that varies with the age of the child. These rates are based on the reasonable costs of caring for the children concerned and are reviewed annually and adjusted to reflect changes in the Consumer Price Index compiled by the Bureau of Labor Statistics. The payments do not include a fee for the foster parents' services in caring for the children. Additional allowances are provided as needed for miscellaneous expenses such as school transportation and supplies, membership in youth organizations, and travel expenses arising because foster children are in the home. Payments for medical and dental care of a foster child are made directly to the medical practitioners by the welfare department.

Situation 3. A married couple entered into a formal agreement with a child-placing agency, a private organization described in section 170(c) of the Code, to provide a foster home for children who are deprived of parental care. Under the terms of the agreement, the foster parents commit themselves to maintain four such children in their home for a period of time extending over several years and to establish a parent-child relationship with them. They provide those items necessary and appropriate to the children, including room, board, clothing, personal needs, medical and dental care, insurance, school expenses, recreation items, transportation, and spending money. Two rooms are set aside to be used exclusively by the children as bedrooms. The foster children assist in such household chores as are normally expected of children in a family, but do not render such household services as would compensate the foster parents for their support. The foster parents are required to keep the child-placing agency informed of the needs, problems, and progress of the children, and to keep a detailed record of expenses attributable to the foster children.

The child-placing agency is committed to make monthly payments to the foster parents covering (1) fixed compensation for the services of the foster parents; (2) a housing payment determined by reference to the foster parents' actual housing expenses but limited to certain maximums; and (3) a per-child support payment that varies with the age of the child. The per-child support payment is reviewed periodically and adjusted to reflect price changes as shown by the detailed record of expenses kept by the foster parents. The total amount received exceeds the expenses incurred in caring for the foster children.

Situation 4. A married couple secured the necessary license and agreed to provide continuous 24-hour maintenance of three spaces in their home for the temporary and emergency care of children to be placed there by the local welfare department. Pursuant to the laws and regulations under which the foster care program is administered, the foster parents provide those items necessary and appropriate to the children (including room, board, clothing, personal needs, and spending money). The foster children assist in such household chores as are normally expected of children in a family, but do not render such household services as would compensate the foster parents for their support. The welfare department inspects the home periodically to insure that the foster children placed there receive proper care and gives counsel and supervision to the foster parents as needed.

The welfare department pays the taxpayers a monthly subsidy for each of the three spaces maintained for the children whether or not the spaces are actually used. In addition, the welfare department pays the taxpayer a monthly per-child amount intended to reimburse the foster parents for the costs of supporting a child and to provide a reasonable profit.

Situation 5. An unmarried taxpayer, who files Federal income tax returns on a calendar year basis, provided a home to a 10-year-old cousin on January 15 of the year in which the child became an orphan and maintained the child there as a member of the taxpayer's household for the remainder of the taxable year. The taxpayer acted as the child's foster parent and guardian, but made no attempt to adopt the child. The taxpayer received no financial assistance from any person or organization, but supported the child entirely from personal resources. The child assists in such household chores as are normally expected of children in a family, but does not render such household services as would compensate the foster parent for the child's support.

As the child's representative payee for social security purposes, the foster parent received the monthly payment of the child's insurance benefits described in section 202(d) of title II of the Social Security Act, as amended (42 U.S.C. section 402 (1970)). However, the taxpayer deposited the entire amount of the benefit payments in a savings account in the child's name, using no part of it for the child's support or for any other purpose.

Section 61(a) of the Code and the Income Tax Regulations thereunder provide that, except as otherwise provided by law, gross income means all income from whatever source derived.

Section 162(a) of the Code provides that there shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on a trade or business. If the trade or business does not consist of the performance of services by the taxpayer as an employee, such deduction is an allowable deduction from gross income under section 62(1). However, if the trade or business consists of the performance of services by the taxpayer as an employee, the deduction is allowable only if the taxpayer itemizes deductions or if the expenses fall into one of the categories set forth in section 62(2).

For taxable years beginning after December 31, 1975, section 280A(a) of the Code provides the general rule that, in the case of a taxpayer who is an individual or an electing small business corporation, no deduction shall be allowed with respect to the use of a dwelling unit that is used by the taxpayer during the taxable year as a residence except as otherwise provided in section 280A. An exception to this general rule is set forth in section 280A(b), which provides that subsection (a) shall not apply to any deduction for interest, taxes, casualty losses, etc., allowable to the taxpayer without regard to its connection with the taxpayer's trade or business (or with the taxpayer's income-producing activity). A further exception is set forth in section 280A(c), which provides that subsection (a) shall not apply to any item to the extent such item is allocable to a portion of the dwelling unit that is used exclusively, regularly, and in specified ways in the taxpayer's trade or business.

Section 151(e) of the Code provides that a dependency exemption is allowed a taxpayer for each dependent, as defined in section 152, whose gross income for the calendar year in which the taxable year of the taxpayer begins is less than $750, or who is a child of the taxpayer and who is under 19 years of age or a student. The term "dependent" as defined in section 152(a)(9) includes a foster child who receives over half of his or her support from the taxpayer and who, for the taxable year of the taxpayer, has as his or her principal place of abode the home of the taxpayer and is a member of the taxpayer's household. Section 1.152-1(b) of the Income Tax Regulations explains that section 152(a)(9) applies only to an individual who lives with the taxpayer and is a member of the taxpayer's household during the entire taxable year of the taxpayer. See Trowbridge v. Commissioner, 30 T.C. 879 (1958), aff'd, 268 F.2d 208 (9th Cir. 1959).

Section 170 of the Code provides that subject to certain limitations a deduction shall be allowed for any charitable contribution (as defined in section 170(c)), payment of which is made within the taxable year. Section 1.170A-1(g) of the regulations provides, in part, that unreimbursed out-of-pocket expenditures made incident to the rendition of services to a charitable organization may constitute a deductible contribution.

The Federal employment taxes of the Federal Insurance Contributions Act, the Federal Unemployment Tax Act, and the Collection of Income Tax at Source on Wages (chapters 21, 23, and 24, respectively, subtitle C of the Code) are imposed on the wages paid to an employee by his employer. An individual is an employee for Federal employment tax purposes if he has the status of employee under the usual common law rules applicable in determining whether an employer-employee relationship exists. Guides for determining whether an employer-employee relationship exists are found in three substantially similar sections of the Employment Tax Regulations, namely sections 31.3121(d)-1(c), 31.3306(i)-1, and 31.3401(c)-1. These sections state that generally, the relationship of employer and employee exists when the person for whom the services are performed has the right to control and direct the individual who performs the services, not only as to the result to be accomplished by the work but also as to the details and means by which that result is accomplished. That is, an employee is subject to the will and control of the employer not only as to what shall be done but how it shall be done. In this connection, it is not necessary that the employer actually direct or control the manner in which the services are performed, it is sufficient if the employer has the right to do so. However, for purposes of the Federal Insurance Contributions Act and the Federal Unemployment Tax Act, the term "employment" does not include service performed in the employ of a state, a political subdivision of a state, or an instrumentality of a state or political subdivision (sections 3121(b)(7) and 3306(c)(7)), or service performed in the employ of an organization described in section 501(c)(3) (sections 3121(b)(8)(B) and 3306(c)(8)).

Section 1401 of the Code imposes a tax on the self-employment income of an individual derived from any trade or business carried on by such individual.

Section 6041(a) of the Code provides, with certain exceptions not here material, that all persons engaged in a trade or business and making payment in the course of such trade or business to another person of $600 or more in any taxable year for certain items, including rent, salaries, wages, compensations, and remunerations, shall file an information return. Section 1.6041-1(b) of the Income Tax Regulations provides that the term "all persons engaged in a trade or business" includes organizations the activities of which are not for the purpose of gain or profit.

The foster parents in Situations 1 and 2 do not have a profit motive and are not, in fact, making a profit. The child-placing agencies rather than the foster parents designate the foster children to be taken into the home of the foster parents. The child-placing agencies have a purpose of providing care and support for foster children and of locating foster parents to provide care and support for foster children. These agencies have a continuing responsibility to supervise the care provided by the foster parents after the placement of a foster child in the foster parents' home and the agencies do, in fact, supervise the care provided by the foster parents. Also, these agencies have the authority to remove a foster child from the home of foster parents who do not provide proper care. Therefore, the foster parents in Situations 1 and 2 are rendering gratuitous services to the child-placing agencies in feeding, clothing, and caring for foster children.

Consequently, the expenses incurred by these foster parents in caring for the foster children are directly connected with and solely attributable to the rendition of gratuitous services to charitable organizations. These expenses are incurred on behalf of and for the use of the charitable organizations. Thus, the payments from the child-placing agencies represent reimbursements or advances for such expenses incurred on behalf of the agencies by the foster parents. In addition, there is no employment relationship between the child-placing agencies and the foster parents, and the foster parents are not engaged in an independent trade or business.

Accordingly, in Situations 1 and 2:

(a) The payments received from the child-placing agency for the support of a foster child are not includible in the gross income of the foster parents for Federal income tax purposes except to the extent that the payments exceed the expenses incurred by the foster parents in supporting the child.

(b) The expenses incurred by the foster parents in supporting a foster child are not deductible under section 162 of the Code.

(c) The foster parents are entitled to a charitable contribution deduction within the limitations of section 170 of the Code for any unreimbursed out-of-pocket expenses incurred in supporting a foster child.

(d) Since the unreimbursed out-of-pocket expense incurred by foster parents are contributions for the use of the child-placing agency, these expenses are not expenses incurred by the foster parents on their own behalf in support of a foster child. Similarly, any reimbursed expenses incurred in supporting a foster child are incurred on behalf of the child-placing agency. Thus, a foster child cannot qualify as a dependent of the foster parents in these situations.

(e) The payments received from a child-placing agency for the support of a foster child are not subject to employment taxes or self-employment taxes.

(f) The child-placing agencies are not required to file information returns under section 6041 of the Code for the payments made to the foster parents.

The foster parents in Situations 3 and 4 do have a profit motive. They are receiving compensation for their services in addition to payments to cover their expenses. Thus, these foster parents are engaged in a trade or business. The child-placing agencies, however, look to the results of the services performed by the foster parents rather than to the details and means by which the results are accomplished. The child-placing agencies do not exercise, nor have the right to exercise, the degree of direction and control over the foster parents necessary to establish an employer-employee relationship for purposes of the Federal employment taxes. Thus, the foster parents are not engaged in the performance of services as employees, but are engaged in an independent trade or business.

The expenses for which these foster parents receive reimbursement or advancement remain the expenses of the child-placing agencies and are incurred on behalf of the child-placing agencies. See, for example, Burnett v. Commissioner, 356 F.2d 755 (5th Cir. 1966); Flower v. Commissioner, 61 T.C. 140 (1973). Thus, a portion of each payment from the child-placing agencies, other than the per-space payment in Situation 4, represent reimbursement or advancement for expenses incurred on behalf of the agency by the foster parents, and the remainder is compensation for their services. The per-space payments received by the foster parents in Situation 4 are remuneration for keeping space available.

Accordingly, in Situations 3 and 4:

(a) The portion of each payment received from a child-placing agency that represents reimbursement or advancement for expenses incurred by the foster parents on behalf of the child-placing agency is not includible in the gross income of the foster parents. The remaining portion of each payment, and the entire per-space payments in Situation 4, are includible in gross income. See Rev. Rul. 68-97, 1968-1 C.B. 34, which deals with subsidy payments made by a state welfare department to foster parents to insure that the foster parents will keep space available for emergency child shelter purposes

(b) The expenses for which reimbursements or advancements are received are not deductible by the foster parents under section 162 of the Code. However, except as specifically disallowed by section 280A, any ordinary and necessary expenses paid or incurred by the foster parents in carrying on the trade or business of caring for foster children for which no reimbursements or advancements are received are deductible under section 162. Further, because any expenses deductible under section 162 are attributable to the individual's independent trade or business and not to services performed as an employee, such expenses may be deducted from gross income in computing adjusted gross income under section 62(1), whether or not deductions are itemized.

(c) The foster parents are not entitled to a dependency exemption for a foster child in these situations because the expenses incurred for the support of the child that were reimbursed by the child-placing agency were incurred on behalf of the agency and any unreimbursed support expenses were incurred in the foster parents' trade or business.

(d) The portion of each payment received from a child-placing agency that represents compensation for services performed by the foster parents (including all reimbursements that exceed the relevant expenses) is gross income derived from a trade or business for purposes of the self-employment tax imposed by section 1401 of the Code. The per-space payments are also gross income from a trade or business for purposes of section 1401.

(e) A child-placing agency is required to file an information return under section 6041 of the Code if the compensation portions of the payments in one set of foster parents total $600 or more in any taxable year.

In Situation 5 the insurance benefits paid under the Social Security Act belong to the child, even though they are paid to the child's representative payee. Rev. Rul. 57-344, 1957-2 C.B. 112. However, such benefits are not includible in the gross income of either the child or the foster parent. Rev. Rul. 70-217, 1970-1 C.B. 12.

The foster parent in this situation is not entitled to a charitable contribution deduction under section 170 of the Code for any of the expenses incurred in supporting the child since these expenses were not incurred on behalf of a charitable organization.

Since the child was not a member of the foster parent's household for the entire taxable year, the foster parent is not entitled to claim a dependency exemption for the foster child for the taxable year. However, if the child otherwise qualifies as the taxpayer's dependent, the taxpayer may claim a dependency exemption for subsequent years in which the child satisfies the specific requirements of section 152(a)(9) of the Code with respect to the taxpayer.

I.T. 4068, 1952-1 C.B. 7, is superseded, since the provisions thereof are restated in this Revenue Ruling.