On June 19, the IRS published proposed regulations implementing a new federal law that authorizes states to offer specially designed tax-favored ABLE accounts to people with disabilities who became disabled before age 26. Until the issuance of final regulations, taxpayers and qualified ABLE programs may rely on the proposed regulations.
Background
On December 19, 2014, the President signed into law the Tax Increase Prevention Act of 2014. This legislation included the Achieving a Better Life Experience Act of 2014, which provides for a new type of tax-advantaged account for disabled persons called an ABLE account.
The tax laws have long encouraged Americans to save for college expenses and retirement. But for families of those with disabilities, there was no tax-advantaged way to save for those individuals.
The new law, which applies for tax years beginning after December 31, 2014, allows states to create ABLE accounts, which are tax-free accounts that can be used to save for disability-related expenses under Section 529 of the Internal Revenue Code. Any state can offer its residents the option of setting up an ABLE account. Or a state can contract with another state that offers such accounts.
The IRS recently proposed regulations that provide implementation guidance to state programs, designated beneficiaries and other interested parties. Here are some key issues that the guidance covers:
ABLE Account Set-up
The IRS recognizes that certain eligible individuals may be unable to establish an account themselves. So, the proposed regs clarify that, if the eligible individual can’t establish the account, the eligible individual’s parent or legal guardian (or his or her agent under a power of attorney) may establish the ABLE account.
A person (other than the beneficiary) with signature authority over the ABLE account can’t have or acquire any beneficial interest in the account during the designated beneficiary’s lifetime. They also must administer the account solely for the benefit of the beneficiary.
Change of Address
The proposed regs allow states to permit a beneficiary to continue to maintain an ABLE account that was created in that state, even after the beneficiary is no longer a resident. To enforce the one-ABLE-account limit, beneficiaries must verify, when creating an ABLE account, that the account being established is the beneficiary’s only ABLE account. An exception is permitted in the case of a rollover or a program-to-program transfer of a beneficiary’s ABLE account. In addition, a prior ABLE account that has been closed doesn’t prohibit the subsequent creation of another ABLE account for the same beneficiary.
Eligibility
When using a disability certification to qualify for an ABLE account, an eligible individual must present the certification and diagnosis to the qualified ABLE program. For purposes of the disability certification, the proposed regs provide that the phrase “marked and severe functional limitations” means the standard of disability in the Social Security Act for children claiming benefits under the Supplemental Security Income (SSI) program based on disability, but without regard to the age of the individual. While evidence of an individual’s eligibility based on entitlement to Social Security benefits should be objectively verifiable, the sufficiency of a disability certification that an individual is eligible for an ABLE account might not be as easy to establish.
Annual recertifications are required to demonstrate that the beneficiary continues to satisfy the definition of an eligible individual. The proposed regs provide flexibility regarding annual recertifications. For example, a qualified ABLE program may permit certification by an individual that he or she has a permanent disability to be considered to meet the annual requirement to present a certification to the qualified ABLE program.
An ABLE program may identify certain impairments or categories of impairments for which recertifications will be deemed to have been made annually unless the qualified ABLE program provides otherwise. For example, annual recertification may be required if, for example, a cure is discovered for a disease that had previously qualified as a permanent disability.
Account Contributions
As a general rule, all contributions to an ABLE account must be made in cash. The proposed regs provide that a qualified ABLE program may accept contributions in the form of cash, check, money order, credit card payment or other similar method of payment. Beneficiaries must return contributions in excess of the annual gift tax exclusion — currently $14,000 per donee — to the contributor, along with all net income attributable to those excess contributions.
Similarly, beneficiaries must return all contributions, along with all net income attributable to those contributions, if an ABLE account exceeds the limit established by the state for its qualified tuition program. All returns should be made on a last-in, first-out basis, under the proposed guidance.
Account Distributions
No distributions from an ABLE account are includible in a beneficiary’s gross income as long as annual distributions don’t exceed the beneficiary’s annual qualified disability expenses. Otherwise, the earnings portion of the distributions from the ABLE account — reduced by the product of such earnings portion and the ratio of the amount of distributions for qualified disability expenses to total distributions — is generally included in the beneficiary’s gross income.
Account Rollovers
The proposed regs indicate that the IRS doesn’t have the authority to permit a tax-free rollover of a Section 529 qualified tuition account into an ABLE account for the same beneficiary.
However, the proposed regs do allow program-to-program transfers to effectuate a change of qualified ABLE program or a change of beneficiary to another eligible individual. Such direct transfers are neither taxable distributions nor excess contributions that must be returned to the contributor. States also may allow a program-to-program transfer through a check delivered to the beneficiary that’s negotiable only by the qualified state program under which the new ABLE account is being established.
Qualified Disability Expenses
Under the proposed guidance, the term “qualified disability expenses” is broadly construed to permit the inclusion of basic living expenses. It’s not limited to expenses for items for which there’s a medical necessity or which provide no benefits to others in addition to the benefit to the eligible individual.
For example, a smart phone could be considered a qualified disability expense if it’s an effective and safe communication or navigation aid for a child with autism. Other items that may qualify as disability expenses are:
- Costs of education,
- Housing,
- transportation,
- Employment training and support,
- Assistive technology and personal support services,
- Health, prevention and wellness,
- Financial management and administrative services,
- Legal fees,
- Expenses for oversight and monitoring, and
- Funeral and burial expenses.
Reporting Requirements
The IRS created the rules for ABLE accounts based loosely on the rules for qualified tuition programs. But qualified ABLE programs will have significant administrative obligations beyond what’s required for the administration of qualified tuition programs, because the frequency of distributions from ABLE accounts is likely to be far greater than those made from qualified tuition accounts.
The IRS plans to develop two new forms that ABLE account programs will use to report relevant account information annually to designated beneficiaries and the IRS: Form 1099-QA for distributions and Form 5498-QA for contributions.
Effective Date
The regulations still haven’t been finalized. So, until then, taxpayers and qualified ABLE programs may rely on the proposed regs. The IRS is soliciting public comments on the proposed guidance through September 21, 2015. For more detailed information about establishing, administering or contributing to an ABLE account, contact your tax adviser.
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