Running an AFH · For owners & buyers

Do Adult Family Homes Pay Taxes? B&O, Sales Tax and the Live-In Medicaid Exclusion

Washington's B&O exemption for licensed adult family homes, the sales tax AFHs still pay, and the federal 'difficulty of care' exclusion for live-in providers: what it covers, its limits, and why the Medicaid program matters.

Written from the HCA, DSHS and Washington rules it cites, checked October 13, 2026. Its primary sources are listed under the author note at the end of the page.

Washington B&O tax: the licensed-AFH exemption

B&O tax is a state tax on a business's gross income. RCW 82.04.327 (Revised Code of Washington) says: "This chapter does not apply to adult family homes which are licensed as such, or which are specifically exempt from licensing, under rules of the department of social and health services." Chapter 82.04 is the B&O tax chapter.

The Department of Revenue (DOR) rule, WAC 458-20-168(9)(c) (WAC is the Washington Administrative Code), explains it. The exemption covers "gross income derived from personal and professional services" of AFHs licensed by the Department of Social and Health Services (DSHS), or specifically exempt from licensing under DSHS rules. It also says: "This exemption does not apply to persons who provide home care services to clients in the clients' own residences."

In plain words: the exemption is tied to the AFH license and covers care services income, not home care in people's own houses. Neither text limits the exemption by the number of homes you own or by how many residents pay with Medicaid.

Sales tax: you still pay it on what you buy

The B&O exemption does not cover sales tax on your purchases. WAC 458-20-168(10) says AFHs and similar care providers "are required to pay retail sales tax on purchases of equipment and supplies," unless a specific exemption in law applies. So beds, lifts, gloves and household goods are normally taxed when you buy them.

Selling goods to residents is a different question. WAC 458-20-168(7) says "Retailing B&O tax applies to sales of tangible personal property sold and billed separately" from care services. It also treats drugs sold for self-administration as taxable unless exempt. Medical supplies used to provide care are not treated as separate sales just because they are itemized. The statute says the whole B&O chapter does not apply to licensed AFHs; the rule is written for health care providers generally. If your home bills residents separately for items, ask DOR or a CPA whether you must collect sales tax and how to report it.

Do you have to register with DOR if your income is exempt?

DOR says you must register and get a business license if, among other reasons, you "plan to hire employees within the next 90 days" or your gross income is "$12,000 per year or more." Most AFHs hire caregivers, so most need a license for that reason alone.

Once registered, even a business with no activity "must still file your return by the due date." DOR's "active non-reporting" status removes filing for some small businesses; one condition is B&O gross income that "is less than $125,000 per year."

We could not find a DOR page saying whether an AFH with only exempt income must file and report it, or whether exempt income counts toward that test. Ask DOR (dor.wa.gov) how to set up your account.

Federal income tax: the "difficulty of care" exclusion

Federal law, 26 U.S.C. § 131, excludes "qualified foster care payments" from income. It includes "difficulty of care payments" for care "provided in the home of the foster care provider."

In 2014 the IRS published Notice 2014-7: "the Service will treat qualified Medicaid waiver payments as difficulty of care payments under § 131(c)." An IRS question-and-answer page (Q&A) explains it:

• Which payments. The IRS names "a state Medicaid Home and Community-Based Services waiver program described in section 1915(c)." For other programs (Q1), it "will depend on the nature of the payments and the purpose and design of the program." That is case by case, not a yes.
• Only in the provider's own home. "A person's 'home' is where he resides." Payments for care "outside of the home where the provider resides" do not qualify. Q3: a provider who "has a separate home" cannot exclude them.
• Five adults per home. Section 131(c)(2) applies "in the case of any foster home" and limits the exclusion to "5 qualified foster individuals" age 19 or over. The notice says waiver payments "are subject to these limits." The IRS does not explain how an AFH maps onto a "foster home."
• Care only. Q8: only "payments for the care" are excludable, so vacation pay is not.
• The resident's share. Q7 covers a program where the individual must "pay the administrator" part of the cost. If the payments otherwise qualify, you may exclude "the entire payment that you receive under the state Medicaid waiver program." But you "may not exclude direct payments from a care recipient" from private funds.
• Earned Income Credit (EIC). Q9: if the payments otherwise count as earned income, you "may choose to include all, but not part, of these payments in earned income."
• Self-employment tax. Q13 (a contractor paid on a Form 1099) and Q14 (a sole proprietor): payments that qualify as excludable are not self-employment income. Payments that do not qualify do not get this treatment.
• Payments to a company. The notice describes payments "to an individual care provider." The IRS sources say nothing about a limited liability company (LLC) or corporation.

Two Washington facts for your CPA. Here the resident pays their share to the home: "A client must pay the client's provider" (WAC 182-515-1509). Q7 describes paying the administrator instead. And the IRS sources never mention adult family homes.

Which Washington Medicaid program pays your residents?

This matters because Notice 2014-7 is written for 1915(c) waiver payments. DSHS official manuals show that Washington AFH residents can be paid through several programs:

• Community First Choice (CFC). DSHS says CFC "is a Medicaid State Plan option granted under 1915(k) of the Social Security Act." It is not a 1915(c) waiver. CFC clients may receive services in an "Adult Family Home (AFH)," and DSHS lists an AFH as a CFC personal care provider.
• COPES (Community Options Program Entry System). DSHS says "COPES is one of the 1915(c) Medicaid waivers" and that its services "act as a wraparound to services available to the Community First Choice (CFC) State Plan program." DSHS adds that since July 1, 2015, "it would be highly unusual for a person to be enrolled in COPES and not also be enrolled in CFC because personal care is no longer available in COPES."
• Other programs. The DSHS residential services chapter lists contracted AFHs as available under CFC, DDA (Developmental Disabilities Administration) waivers, Medicaid Personal Care (MPC), COPES, the Residential Support Waiver, Roads to Community Living (RCL) and State-funded Medical Care Services (MCS).

So the personal care payment for many residents may come through CFC, a state plan program. The IRS names only 1915(c) waivers and says other programs depend on "the nature of the payments and the purpose and design of the program." The IRS sources we read do not mention CFC or 1915(k), so this page does not say whether CFC payments are excludable.

Practical step: for each resident, ask the DSHS case manager which program pays for the care, and give that to your CPA. The program codes and rates behind your payments are explained in the AFH payment field guide and Getting paid: ProviderOne billing.

What this means when you buy or sell an AFH

The federal rules depend on who gets paid and where they live, so two homes with the same Medicaid income can produce different after-tax results. A live-in provider may be able to exclude qualifying payments, within the five-person limit. An owner who lives elsewhere does not meet the "own home" test (Q3). An LLC or corporation owner faces a question the IRS does not answer. An owner of two homes can live in only one.

A seller's after-tax result may not carry over to a buyer. Lenders read tax returns, not projections; see How to finance an AFH. Have a CPA model your own situation before you set a price or make an offer. Related pages: Individual or LLC, Selling your AFH business at retirement, the AFH valuation estimator and Before you buy: what to verify.

What to do next

• Keep your license current; the B&O exemption depends on it. See Licensing & certification.
• Ask DOR how to register and file when your income is exempt.
• For each Medicaid resident, write down the program (CFC, COPES or other) and take it to a CPA.
• Buying or selling? Have a CPA compare the seller's tax position with yours. See Running a licensed home.