You can choose to include the payments as earned income, but you are not required to. The way you entered the payments (a positive and negative entry to other income), the amounts are not included as wages for the purposes of the Earned Income Credit. If you want to include the income for the purposes of the EIC or if you want to see how it affects your EIC, you would enter the W-2 as is and only enter the negative entry in the other income section.
Even though Medicaid Waiver Payments are not taxable for federal income tax purposes, the payments can be used to calculate the earned income tax credit. In a recent court case, it was ruled that Medicaid Waiver Payments are considered "earned income" for purposes of calculating the earned income tax credit. A taxpayer can choose to include Medicaid Waiver Payments as Wages on line 1 of Form 1040 (even if not reported on a W-2) in order to claim the credit. Then an adjustment is entered on Schedule 1, line 8 so the payments are not included in taxable income.
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