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In-Depth: IRS Issues Proposed Regulations for Section 529A ABLE Programs.

(Parker Tax Publishing July 11, 2015)

The IRS has issued proposed regs under Code Sec. 529A that provide guidance regarding programs under the Achieving a Better Life Experience (ABLE) Act of 2014. Code Sec. 529A provides rules under which states may establish and maintain a new type of tax-favored savings program through which contributions may be made to the account of an eligible disabled individual to meet qualified disability expenses. REG-102837-15.

Background

The Achieving a Better Life Experience (ABLE) Act of 2014, enacted on December 19, 2014 as part of The Tax Increase Prevention Act of 2014, added Code Sec. 529A, providing a new type of tax-advantaged savings plan for disabled individuals. Dubbed "ABLE" plans, the new Code Sec. 529A plans are modeled after Code Sec. 529 Qualified Tuition Plans.

Beginning in 2015, Code Sec. 529A allows the creation of a qualified ABLE program by a state, under which a separate ABLE account may be established for a disabled individual who is the designated beneficiary and owner of the account. Generally, contributions to that account are subject to both an annual and a cumulative limit, and, when made by a person other than the designated beneficiary, are treated as non-taxable gifts. Distributions made from an ABLE account for qualified disability expenses are not included in the designated beneficiary's gross income.

Congress recognized the special financial burdens borne by families raising children with disabilities and the fact that increased financial needs generally continue throughout the disabled person's lifetime. Prior to the enactment of the ABLE Act, various types of tax-advantaged savings arrangements existed, but none adequately served the goal of promoting saving for these financial needs.

One of the purposes of the Act is to provide secure funding for disability-related expenses that will supplement, but not supplant, benefits otherwise available to disabled individuals. Because so many of the programs that provide essential financial, occupational, and other resources and services to disabled individuals are available only to persons whose resources and income do not exceed relatively low dollar limits, the Act generally provides that a designated beneficiary's ABLE account is disregarded for purposes of determining eligibility for and the amount of any assistance or benefit provided under certain means-tested Federal programs.

Notice 2015-18 provides that, in the event that state legislation creating ABLE programs, enacted in accordance with Code Sec. 529A prior to issuance of guidance, does not fully comport with the guidance when issued, the IRS will provide transition relief to guarantee sufficient time to allow states to implement the changes necessary to avoid the disqualification of the state program and of the ABLE accounts already established under the state program. States that enact legislation creating an ABLE program in accordance with Code Sec. 529A, and those individuals establishing ABLE accounts in accordance with such legislation, will not fail to receive the benefits of Code Sec. 529A merely because the legislation or the account documents do not fully comport with the final regulations when they are issued.

The regulations are proposed to be effective when finalized, but until the issuance of final regulations, taxpayers and qualified ABLE programs may rely on the proposed regulations.

Qualification as an ABLE program

In order to be a qualified ABLE program, the program must:

(1) Be established and maintained by a state or a state's agency or instrumentality;

(2) Permit the establishment of an ABLE account only for a designated beneficiary who is a resident of that state, or a state contracting with that state for purposes of the ABLE program;

(3) Permit the establishment of an ABLE account only for a designated beneficiary who is an eligible individual;

(4) Limit a designated beneficiary to only one ABLE account, wherever located;

(5) Permit contributions to an ABLE account established to meet the qualified disability expenses of the account's designated beneficiary;

(6) Limit the nature and amount of contributions that can be made to an ABLE account;

(7) Require a separate accounting for the ABLE account of each designated beneficiary with an ABLE account in the program;

(8) Limit the designated beneficiary to no more than two opportunities in any calendar year to provide investment direction, whether directly or indirectly, for the ABLE account; and

(9) Prohibit the pledging of an interest in an ABLE account as security for a loan.

Establishment of an ABLE program and individual account

The proposed regulations provide that an ABLE program is established by a state if the program is initiated by state statute or regulation, or by an act of a state official or agency with the authority to act on behalf of the state. A program is maintained by a state if all the terms and conditions of the program are set by the state, and the state is actively involved on an ongoing basis in the administration of the program, including supervising all decisions relating to the investment of assets contributed to the program.

The designated beneficiary of an ABLE account is the eligible individual who establishes the account, or an eligible individual who succeeded the original designated beneficiary. The designated beneficiary is considered the owner of that account. If the eligible individual cannot establish the account themselves, the eligible individual's agent under a power of attorney or, if none, his or her parent or legal guardian may establish the ABLE account. A person other than the designated beneficiary with signature authority over the ABLE account may neither have, nor acquire, any beneficial interest in the account during the designated beneficiary's lifetime and must administer the account for the benefit of the designated beneficiary.

Certification of Disability Required

At the time an ABLE account is created, the designated beneficiary must provide evidence that he or she is an eligible individual. Under Code Sec. 529A(e)(1), an individual is an eligible individual for a tax year if, during that year, either the individual is entitled to benefits based on blindness or disability under Title II or XVI of the Social Security Act and the blindness or disability occurred before the date on which the individual attained age 26, or a disability certification meeting specified requirements is filed with the IRS.

Although 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 an eligible individual for purposes of Code Sec. 529A might not be as easy to establish. To facilitate an eligible individual's ability to establish an ABLE account without undue delay, the proposed regulations provide that an eligible individual must present the disability certification, accompanied by the diagnosis, to the qualified ABLE program to demonstrate eligibility to establish an ABLE account; the disability certification will be deemed to be filed with the IRS once it is received by the qualified ABLE program.

Because there may be circumstances in which a designated beneficiary ceases to be an eligible individual but subsequently regains that status, the proposed regulations provide that if at any time a designated beneficiary no longer meets the definition of an eligible individual, his or her ABLE account remains an ABLE account to which all of the provisions of the ABLE Act continue to apply, and no (taxable) distribution of the account balance is deemed to occur. However, beginning on the first day of the tax year following the tax year in which the designated beneficiary ceased to be an eligible individual, no contributions to the ABLE account may be accepted. If the designated beneficiary subsequently again becomes an eligible individual, then additional contributions may be accepted subject to the applicable annual and cumulative limits.

OBSERVATION: Expenses will not be qualified disability expenses if they are incurred at a time when a designated beneficiary is not disabled.

A qualified ABLE program generally must require annual recertification that the designated beneficiary continues to satisfy the definition of an eligible individual. However, a qualified ABLE program may deem an annual recertification to have been provided in appropriate circumstances, such as through a certification by an individual that he or she has a permanent disability.

Contributions to an ABLE account

Under Code Sec. 529A(b)(4), a qualified ABLE program must provide that the designated beneficiary may directly or indirectly direct the investment of any contributions to the program or any earnings thereon no more than two times in any calendar year.

As a general rule, all contributions to an ABLE account must be made in cash. In addition, the proposed regulations provide that the total contributions to an ABLE account in the designated beneficiary's tax year, other than amounts received in rollovers and program-to-program transfers, must not exceed the amount of the annual per-donee gift tax exclusion under Code Sec. 2503(b) in effect for that calendar year (currently $14,000 for 2015) in which the designated beneficiary's taxable year begins. The proposed regulations provide that contributions to an ABLE account by a person other than the designated beneficiary are treated as completed gifts to the designated beneficiary of the account, and that such gifts are neither gifts of a future interest nor a qualified transfer under Code Sec. 2503(e). Accordingly, no distribution from an ABLE account to the designated beneficiary of that account is treated as a taxable gift.

A qualified ABLE program must return contributions in excess of the annual gift tax exclusion to the contributor(s), along with all net income attributable to those excess contributions. Similarly, the proposed regulations require the return of all contributions, along with all net income attributable to those contributions, causing an ABLE account to exceed the limit established by the state for its qualified tuition program. A qualified ABLE program must provide adequate safeguards to ensure that total contributions to an ABLE account (including the proceeds from a preexisting ABLE account) do not exceed that state's limit for aggregate contributions under its qualified tuition program.

Gift tax consequences may arise from contributions to an ABLE account even though the aggregate amount of such contributions from all contributors may not exceed the annual exclusion amount under Code Sec. 2503(b) applicable to any single contributor. Specifically, if a contributor makes other gifts to a designated beneficiary in addition to the gift to the designated beneficiary's ABLE account, the contributor's total gifts made to the designated beneficiary in that year could give rise to a gift tax liability.

Distributions

If distributions from an ABLE account do not exceed the designated beneficiary's qualified disability expenses, no amount is includible in the designated beneficiary's gross income. Otherwise, the earnings portion of the distributions from the ABLE account, as determined under Code Sec. 72, reduced by the product of such earnings portion and the ratio of the amount of the distributions for qualified disability expenses to total distributions, is includible in the gross income of the designated beneficiary to the extent not otherwise excluded from gross income.

For purposes of applying Code Sec. 72 to amounts distributed from an ABLE account, the proposed regulations provide that:

(1) all distributions during a tax year are treated as one distribution; and

(2) the value of the contract, income on the contract, and investment in the contract are computed as of the close of the calendar year in which the designated beneficiary's tax year begins.

In addition to the income tax on the portion of a distribution included in gross income, an additional tax of 10 percent of the amount includible in gross income is imposed. This additional tax does not apply to distributions on or after the designated beneficiary's death or to returns of excess contributions or contributions to additional purported ABLE accounts made by the due date (including extensions) of the designated beneficiary's tax return for the year in which the relevant contributions were made.

Although a qualified ABLE program generally is exempt from income taxation, the proposed regulations provide that, upon the death of the designated beneficiary, all amounts remaining in the ABLE account are includible in the designated beneficiary's gross estate for purposes of the estate tax.

Rollovers

Code Sec. 529A(c)(1)(C) addresses the tax consequences of the rollover of an ABLE account to an ABLE account for the same designated beneficiary maintained under a different state's qualified ABLE program, as well as a change of designated beneficiary. The proposed regulations provide that in these two situations, amounts will not be includible in income if there is any change of designated beneficiary and the new designated beneficiary is both an eligible individual for his or her tax year in which the change is made and a sibling of the former designated beneficiary. Additionally, a distribution will be excluded from gross income if the distribution is paid, not later than the 60th day after the date of the distribution, to another (or the same) ABLE account for the benefit of the designated beneficiary or for the benefit of an eligible individual who is a sibling of the designated beneficiary. However, this exception will not apply to a distribution that occurs within 12 months of a previous rollover to another ABLE account for the same designated beneficiary.

The proposed regulations also authorize a qualified ABLE program to allow program-to-program transfers to allow a change of qualified ABLE program or a change of designated beneficiary to another eligible individual.

OBSERVATION: IRS has been asked whether a qualified tuition account under Code Sec. 529 may be rolled into an ABLE account for the same designated beneficiary free of tax. Because such a distribution to the ABLE account would not constitute a qualified higher education expense under Code Sec. 529, the IRS does not believe it has the authority to allow such a transfer on a tax-free basis.

Qualified disability expenses

The proposed regulations provide that qualified disability expenses are expenses that relate to the designated beneficiary's blindness or disability and are for the benefit of that designated beneficiary in maintaining or improving his or her health, independence, or quality of life. Such expenses include, but are not limited to, expenses for 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, funeral and burial expenses, and other expenses that may be specified in future IRS guidance.

The IRS has concluded that the term "qualified disability expenses" should be broadly construed to permit the inclusion of basic living expenses and should not be limited to expenses for items for which there is a medical necessity or which provide no benefits to others in addition to the benefit to the eligible individual. For example, expenses for common items such as smart phones could be considered qualified disability expenses if they are an effective and safe communication or navigation aid for a child with autism.

Limitation on number of ABLE accounts of a designated beneficiary

The proposed regulations provide that, except with respect to rollovers and program-to-program transfers, no designated beneficiary may have more than one ABLE account in existence at the same time. In the event an additional ABLE account is opened for a designated beneficiary with an ABLE account already in existence, only the first such account created for that designated beneficiary qualifies as an ABLE account.

The prohibition of multiple ABLE accounts does not prevent a timely rollover or program-to-program transfer of the designated beneficiary's account to an ABLE account under a different qualified ABLE program.

Residency requirements

The proposed regulations require that an ABLE account for a designated beneficiary may be established only under the qualified ABLE program of the state in which that designated beneficiary is a resident or with which the state of the designated beneficiary's residence has contracted for the provision of ABLE accounts. If a state does not establish and maintain a qualified ABLE program, it may contract with another state to provide an ABLE program for its residents.

Due to concerns about imposing undue administrative burdens and costs on designated beneficiaries who frequently change state residency, such as members of military families, the proposed regulations provide that a qualified ABLE program may permit a designated beneficiary to continue to maintain his or her ABLE account that was created in that state, even after the designated beneficiary is no longer a resident of that state. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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