I have 2014-7 excludable IHSS income. $0 shows for income and FITW. However, Colorado state income tax was withheld which I need to enter. But TurboTax won't let me enter this unless I paper file my federal return.

[shootastour]

Married filing jointly.  My wife is the one who receives the IHSS income which is not counted toward federal income.  Her employer correctly shows zero federal wages and zero federal tax withheld.  However, Colorado still requires the income to have state income tax withheld and thus she had it withheld.  But the catch 22 is that TurboTax won't let me e-file the federal return if a W2 shows zero income.  But if I remove the W2, the State return doesn't correctly show the correct refund amount because it doesn't see the proper state tax that was withheld since TurboTax won't allow that W2 to be entered and still be able to file the federal portion.

[MaryM428 · Accepted solution]

If the W-2 shows $0 in box 1 - leave the entire W-2 out.

If the W-2 shows an amount in box 1 - follow these steps:
 

Do not enter the W-2 in the Wages & Salaries topic. Instead enter it as Other Reportable Income under the Miscellaneous Income section. Take the following steps: 

1. Sign in to TurboTax Online, click Continue your return, then pick up where I left off (if you are using TurboTax CD/ Download, then just open your return on your computer);

1. Click on Federal Taxes at the top of the screen;
2. At the bottom of Your Income box pick the option in blue to help me add other income, then jump to full list;
3. Scroll down the page to the last section titled: Less common Income and click show more;
4. Select start or update next to the last topic titled Miscellaneous Income, 1099-A, 1099-C;
5. Scroll down to the last option titled Other reportable income and select start or edit;
6. When it asks, "Any other reportable income?" say yes then you will make two entries:
7. Your first entry description would be W-2 EIN # (enter EIN number from W-2) Box 1 Medicaid Waiver Payments, and enter the Box 1 amount as a positive number.
8. Next you click "Add Another Miscellaneous Income Item," and enter this description: IRS Notice 2014-7 excludable income and enter the W-2 Box 1 amount as a Negative (-) number. 

This both shows and explains removing the W-2 income, placing a zero on Line 21 of your Form 1040. 

If your W-2 has federal or state taxes withheld, you can enter these amounts in the Deductions & Credits section under Other Income Taxes as Withholding not already entered on W-2.

For more information, refer to IRS Notice 2014–7, 20144 I.R.B. 445 and the IRS FAQs.

[shootastour]

"If your W-2 has federal or state taxes withheld, you can enter these amounts in the Deductions & Credits section under Other Income Taxes as Withholding not already entered on W-2."

GENIUS!  Thank you!  I don't know how I missed this!  This is the answer.  I have asked so many and got every alternative other than this.

[Steve371]

I disagree with Mary.

The correct way to enter it is to enter the W-2 as you normally would and offset it in Miscellaneous income citing 2014-7 Medicaid Waiver Payments or Caregiver Payments.

It is discussed in another thread, "IRS Notice 2014-7 excludable income", but caregiver payments are consider earned income and count towards the Earned Income Tax Credit and other areas, but the offset zeros out the income for federal purposes.  It also makes it easier for the IRS to match W-2s.

If the income is taxable on the state return, then there should be an adjustment on the state return to add it back it.

This is the heart of Notice 2014-7 and it maintains all the benefits the taxpayer(s) is/are entitled to.