On June 19, 2015, the IRS issued proposed regulations (REG-102837-15) that provide authority on new qualified Achieving a Better Life Experience (ABLE) programs for eligible taxpayers who meet the disability requirements for these accounts. The proposed regulations may be relied on until final regulations are issued. ABLE programs will be available for tax years beginning after Dec. 31, 2014, and will be established and maintained on a state-by-state basis. The legislation creating ABLE accounts was passed as part of the Tax Increase Prevention Act of 2014, P.L. 113-295. These programs open up additional tax saving opportunities for qualified taxpayers.
While ABLE programs are new, the concepts behind them are not. An ABLE program allows a taxpayer to contribute cash to an account, invest the money in a way the taxpayer chooses, and take tax-free distributions from the account to use toward qualified disability expenses.
The regulations strictly limit the taxpayer's ability to change the investment of contributions to the program. According to Sec. 529A(b)(4), a program will not be treated as a qualified ABLE program unless it provides that any designated beneficiary under the program may direct the investment of any contributions to the program (or any earnings) no more than two times in any calendar year. Many other rules in the proposed regulations provide guidance on requirements to be eligible for an ABLE account, qualified disability expenses, limits on contributions and distributions, as well as other issues. In considering tax planning opportunities and strategies, it is important to understand all these details.
To be eligible for an ABLE account, a qualified individual must be deemed disabled before the age of 26. Sec. 529A(e)(1) lists two ways to satisfy the disability requirement: (1) The individual is entitled to benefits based on blindness or disability under Title II or XVI of the Social Security Act, or (2) the individual files a disability certification with the IRS for the tax year. The disability certification must state the individual has a medically determinable physical or mental impairment that results in marked and severe functional limitations and that can be expected to result in death or have lasted for a continuous period of not less than 12 months, or is blind, determined before the age of 26. Outside of the disability requirements, an eligible individual can have only one ABLE account at any time, and the individual must be a resident of the state in which the account is maintained (or of a state contracting with that state). Eligibility needs to be redetermined annually.
Because eligible individuals often will not be able to set up their own accounts because of their disabilities, the rules allow a person with a power of attorney or the individual's parent or guardian to set up the account.
Qualified Disability Expenses
The regulations provide a relatively broad definition for qualified disability expenses. An expense is a qualified disability expense if it is related to the eligible individual's blindness or disability and it is made for the benefit of the eligible individual. The regulations provide examples, including expenses for education, housing, transportation, employment training and support, assistive technology and personal support services, health, prevention and wellness, financial management and administration services, legal fees, expenses for oversight and monitoring, funeral and burial costs, and other expenses the IRS approves. It seems almost any expense related to the disability, and related to managing the account as well as the investments, is a qualified disability expense.
Contributions and Distributions
Contributions to an individual's ABLE account for a particular year may not exceed the amount of the annual Sec. 2503(b) gift tax exclusion for that tax year. For 2015, this amount is $14,000, and it is adjusted annually for inflation. The regulations specify any amounts contributed in excess of the annual gift tax exclusion must be returned to the contributor, including any income associated with the excess contribution, on a last-in, first-out basis by the due date of the individual's tax return (including extensions) for the year in which the contributions were made. Excess contributions are subject to a 6% excise tax if they are not returned.
Distributions from an individual's ABLE account are tax-free to the extent the money is used to pay for qualified disability expenses. Any amounts distributed in excess of qualified disability expenses must be included in the individual's taxable income and will be subject to a 10% penalty. The 10% penalty will not apply if the distribution is on or after the death of the account beneficiary.
Tax Planning Opportunities
With the introduction of ABLE accounts available for use in the 2015 tax year, qualified individuals have additional tax planning opportunities to consider. The proposed regulations do not specify that contributions to ABLE accounts must be made from earned income. A qualified individual can therefore make contributions to an ABLE account using income from interest, dividends, capital gains, or other investments. In addition, similar to a Roth IRA, any income earned on money contributed to an ABLE account is tax-free to the extent distributions are used for qualified disability expenses. There are no limitations on how much investment income the ABLE account can earn. As discussed previously, the only limitation for investments is the number of times per year the beneficiary can direct the investments. These benefits make it worthwhile to determine whether an individual qualifies for an ABLE account.
ABLE programs are a great new tool from the IRS and state taxing authorities to level the playing field for individuals with disabilities. These programs create beneficial tax planning opportunities by providing a generous contribution limit and tax-free distributions for qualifying disability expenses. They are also useful for disabled individuals because these accounts are generally not counted when determining these individuals' qualification for needs-based federal programs. Eligible individuals (or their families or guardians) should consider and take advantage of this new tool.
Mark Cook is a partner with SingerLewak LLP in Irvine, Calif.
For additional information about these items, contact Mr. Cook at 949-261-8600 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with SingerLewak LLP.