Final Section 529A ABLE Plan Regulations Are Well-Intended But Will Require Further Clarification
On October 2, 2020, the Internal Revenue Service released final regulations providing guidance for Section 529A “qualified ABLE programs” established by states under the Stephen Beck Jr. Achieving a Better Life Experience Act of 2014 (the “ABLE Act”) to provide tax-favored savings and investment accounts for individuals with disabilities. Building on proposed regulations issued in 2015 and 2019 and several prior IRS notices as to how the final regulations would resolve specific issues under the ABLE Act, the final regulations clearly seek to avoid, within statutory constraints, imposing major administrative burdens on ABLE programs. Nonetheless, several key provisions contain ambiguities or raise concerns. As indicated by prior IRS guidance, the regulations provide a transition period of at least two years for ABLE programs operating in good faith to implement provisions applicable to such programs, and thus an opportunity for the IRS to address such ambiguities and concerns through notices or other guidance prior to their full implementation.
Certain of the final regulation provisions, though technically not applicable to Section 529 college savings programs, may reflect IRS thinking on cognate statutory provisions under Section 529, and therefore may be of interest to such programs.
The final regulations are lengthy and detailed. Certain select provisions are summarized below.
- Effective Date. The final regulations are generally effective as of January 1, 2021, but the regulations provide transition relief for ABLE programs. (These transition provisions generally are not applicable to the tax treatment of beneficiaries.) Programs established and operated “in accordance with a reasonable, good faith interpretation of Section 529A” will not be disqualified for failure to comply with provisions of the final regulations for a period ending two years from the date of publication of the final regulations in the Federal Register or, if later, the day preceding the applicable program’s first taxable year beginning after the close of the applicable state legislature’s first regular session beginning after such publication date.
- Multi-state programs. The final regulations provide that an ABLE program may be maintained by two or more states (or the agencies or instrumentalities of two or more states) if each of the states represented in the program sets all the terms of the program and is actively involved in the program’s administration, including supervising implementation of decisions relating to the investment of program assets. Somewhat confusingly, the final regulations state that “if a State or an agency or instrumentality of a State participates in such a consortium of States or agencies or instrumentalities of States, the consortium’s program is considered to be the program of each State represented.” The latter provision may be best interpreted as suggesting that the portion of a consortium’s jointly-administered program that relates to a particular state is considered that state’s ABLE program for tax purposes, as opposed to requiring that each of multiple states treat the entire ABLE program as its own program for tax purposes. The distinction makes a difference, for example, with respect to the aggregate contribution limit, which under Section 529A cannot exceed the applicable state’s aggregate contribution limit for its Section 529 college savings program. Further clarifying guidance from IRS on this topic may be beneficial.
- Persons eligible to establish an ABLE account on behalf of the beneficiary. The final regulations broaden the categories of people who may establish an ABLE account for an eligible beneficiary and also appear intended to simplify the ABLE program’s duties in connection with policing who establishes the account. The final regulations permit a beneficiary to designate any person to establish an ABLE account, and provide that, if the beneficiary is unable to establish his or her own ABLE account, the account may be established on behalf of the eligible individual by his or her agent under a power of attorney or, if none, by a conservator or legal guardian, spouse, parent, sibling, grandparent, or a representative payee appointed by the Social Security Administration, in that order. The final regulations do not permit an ABLE account to be established as an UGMA or UTMA account. Importantly, the preamble to the final regulations states that “to further facilitate the establishment of ABLE accounts without imposing undue burden on the program or the eligible individuals, the final regulations permit a qualified ABLE program to accept a certification by an individual, under penalties of perjury, that he or she is authorized to establish the ABLE account for the benefit of the eligible individual and that there is no other willing and able person with a higher priority under the regulatory priority listing for establishing an account." Unfortunately, the cross-references in the actual regulations only provide for such reliance on such certification with respect to whether the beneficiary himself or herself or a beneficiary designee is available to establish the account, not as to the order of priority among persons other than the beneficiary or a beneficiary designee. In order to provide the intended relief from “undue burden on the program or the eligible individuals,” the IRS should be asked to fix by additional guidance what appears to be a drafting glitch.
- Persons with signature authority over ABLE account. The final regulations provide a substantial amount of optionality as to the identity and number of people with signatory authority over an ABLE account. Generally, the person establishing the account has signature authority; however, the final regulations permit the beneficiary to replace the person with signature authority with the beneficiary or a beneficiary designee. The beneficiary also may designate a successor to the person with signature authority, and if the beneficiary does not do so, the person with signature authority may do so. An ABLE program may (but is not required to) permit co-signatories, with either joint or several signing authority over all aspects of the account, including investment decisions and distributions. The co-signatory provisions appear to require adherence with the order of priority of signatories provisions, presumably adjusted for the existence of multiple signatories. In addition, an ABLE program may (but is not required to) permit the person with signature authority for the entire account to establish different subaccounts within an ABLE account with different people as signatories for the sole purpose of authorizing distributions from the applicable subaccount; the person with overall signatory account may subsequently revoke any such sub-account distribution authority.
- One account rule. The final regulations provide additional limited relief from the denial of ABLE account status to subsequently established ABLE accounts for the same beneficiary while a prior account remains open. Under the final regulations, an ABLE program is required to obtain a verification signed under penalties of perjury by the person establishing an ABLE account that such person neither knows nor has reason to know that the beneficiary already has an existing ABLE account (other than an ABLE account that will terminate with a rollover or program-to-program transfer to the account being established.) If, notwithstanding such certification, another ABLE account for the same beneficiary has been established (presumably in another state’s program), the subsequently established ABLE account will maintain ABLE status provided that, by the due date (including extensions) of the beneficiary’s federal tax return for the taxable year in which the subsequent ABLE account is established, all of the contributions to the subsequent account, together with earnings, are returned to the contributor(s) in accordance with the rules that apply to the return of excess contributions, or are transferred to the beneficiary’s preexisting ABLE account, with any amounts that cannot be so transferred being returned to the contributor(s).
- Disability certification. As promised in IRS Notice 2015-81, for purposes of establishing a beneficiary’s eligibility for an ABLE account by means of a disability certification, the final regulations permit an ABLE program to rely upon a certification signed under penalties of perjury by the individual, or by another individual establishing the ABLE account for the individual. The final regulations provide that such certification must state that (i) the beneficiary (A) has a medically determinable physical or mental impairment that results in marked and severe functional limitations (as defined in the regulations), and that can be expected to result in death, or has lasted or can be expected to last for a continuous period of not less than 12 months; or (B) Is blind (within the meaning of section 1614(a)(2) of the Social Security Act); (ii) that such blindness or disability occurred before the date on which the individual attained age 26; and (iii) that the beneficiary has obtained and will continue to retain a copy of the diagnosis relating to the individual’s relevant impairment or impairments, signed by a physician meeting the criteria of 42 U.S.C. 1395x(r). As hinted at in IRS Notice 2015-81, the final regulations require that such certification include the name and address of the diagnosing physician and the date of the diagnosis. As is the case with the statutory language, there is no regulatory requirement as to the recency of the date of diagnosis.
- Eligibility recertifications. One of the more administratively complex areas for ABLE programs stems from the statutory requirement that a beneficiary maintain eligibility in each tax year. The final regulations do not do much to resolve the complexity. The regulations require the program to obtain annual recertifications unless the program adopts an alternative method, and state that “alternative methods may include, without limitation, the use of certifications by the designated beneficiary under penalties of perjury, and the imposition of different recertification frequencies for different types of impairments.” The preamble to the regulations states that “this gives each qualified ABLE program broad discretion to devise its own recertification methods [and] is broad enough to permit many of the approaches suggested by commenters, other than the suggestions regarding the elimination of the recertification requirement entirely.” It seems clear that an annual recertification under penalties of perjury of continuation of the applicable disability satisfies the recertification requirement. Programs seeking to minimize the frequency of recertification without entering the mare’s nest of deciding appropriate recertification periods for each type of disability apparently may use the obliquely referenced “enforceable obligation” on the designated beneficiary or other person with signature authority to promptly report changes in the designated beneficiary’s condition that would result in the designated beneficiary’s failing to satisfy the definition of an eligible individual. The “enforceable obligation” apparently permits a program not to require annual recertification for beneficiaries that have promised to report any change in such status, provided such obligation to report is “enforceable.” The regulations shed no light on what makes such a prompt disclosure undertaking “enforceable.”
- Consequences of loss of eligibility. Consistent with the proposed regulations, the final regulations provide that an ABLE account remains an ABLE account even if a beneficiary who was eligible when the account was established subsequently loses eligibility as a result of an improvement in the beneficiary’s condition. Consistent with the proposed regulations, the ABLE program is required to cease accepting additional contributions to the account “beginning on the first day of the beneficiary’s first taxable year for which the designated beneficiary does not satisfy the definition of an eligible individual”, with the preamble to the regulations clarifying that this refers to the first taxable year following the year in which the beneficiary no longer satisfies the eligible individual criteria. It thus appears that, for a program that requires annual recertifications and is unable to obtain one for a beneficiary during a particular calendar year, the prohibition on additional contributions perhaps kicks in as of January 1 of the year following the year in which no certification is obtained, even though the beneficiary may have ceased to be disabled or blind during the year preceding the year in which no disability certification is received by the program. However, unlike the proposed regulations, the final regulations specify that withdrawals made from an ABLE account on any date after the date on which the beneficiary is neither disabled nor blind are not qualified disability expenses, even if the ABLE program may still accept contributions to the account.
- Definition of qualified disability expenses. The final regulations maintain the open-ended and broad definition of the proposed regulations, including the provision that “qualified disability expenses include basic living expenses and are not limited to items for which there is a medical necessity or which solely benefit an individual with a disability.”
- Rollovers. The final regulations confirm that an ABLE program must establish a beneficiary’s eligibility when an account is established in connection with a program to program transfer, to the same extent as an account initially funded by other means. The final regulations also provide that an ABLE program with a lower maximum contribution limit may accept a transfer from another ABLE program that causes such maximum contribution limit to be exceeded. While this provision is unlikely to come into play for ABLE programs in the near future given the low annual contribution limits, it may be of interest to section 529 college savings programs which sometimes struggle with the permissibility of accepting rollovers or transfers from other section 529 programs that cause the accepting state’s maximum contribution limit to be exceeded. The final regulations also clarify that upon a rollover or program-to-program transfer, for purposes of applying the annual contribution limit to the transferee account, annual contributions to the transferor account must be included if the beneficiary remains unchanged, and that, in such circumstances, investment exchanges made during the applicable year in the transferor account count towards the twice per year investment exchange limit.
- Cumulative Contribution Limit. For purposes of compliance with the cumulative contribution limit, which is based on the applicable state’s cumulative contribution limit for its Section 529 college savings program, the final regulations establish a safe harbor under which the requirement is met if the state ceases to accept additional contributions once the cumulative limit amount is reached (subject to the rollover exception mentioned above). The safe harbor provides that, once the ABLE account balance subsequently falls below the cumulative contribution limit, contributions may resume, subject to the annual and cumulative limits. Again, while this provision is unlikely to come into play for ABLE programs in the near future, it may be of interest to section 529 college savings programs which sometimes struggle with the permissibility of accepting additional contributions following withdrawals that cause the account balance to revert to an amount below the maximum contribution limit.
- Annual Contribution Limit. The final regulations do not provide useful guidance on the interplay between the “regular” annual contribution limit (a dollar amount equal to the annual gift tax exclusion) and the additional contribution permitted for certain employed or self-employed beneficiaries (an amount equal to the lesser of the beneficiary’s compensation for the taxable year or an amount equal to the prior year poverty line for a one-person household in the beneficiary’s state of residence.) The final regulations state that “once the designated beneficiary has made contributions equal to the limit [for additional employer contributions], additional contributions by the designated beneficiary may be made if permissible under [the “regular” annual contribution limit.]" That seems relatively obvious. But as the “additional” contribution is intended to expand the amount that can be funded annually, the regulations should have clearly stated, but do not, that the sequencing of contributions by the beneficiary and other contributors to an ABLE account makes no difference, as long as the program tracks contributions to ensure that the annual contributions do not exceed the regular limit (irrespective of who the contributors are) plus an additional amount, if contributed by the beneficiary, equal to the permitted additional contribution. Perhaps that is the intent of the statement in the preamble to the final regulations that “Treasury Department and the IRS believe each qualified ABLE program has the flexibility to determine how to identify contributions from the designated beneficiary that are compensation contributions subject to the new contribution limit.”
- Contributions by Employed Beneficiaries. Consistent with the 2019 proposed regulations, the final regulations permits an ABLE program to rely on a certification under penalties pf perjury by the beneficiary (or a person acting on his or her behalf) that the beneficiary is an “employed designated beneficiary” eligible to make additional annual contributions to the beneficiary’s account and that the additional contributions made do not exceed the amount permissible for such beneficiary under the statutory and regulatory provisions applicable to such employed beneficiaries.
- Limit on Annual Exchanges Between Investment Options. The final regulations helpfully exclude transfers of any part of the account balance “from an investment option to a cash equivalent option to effectuate a distribution” from the two times per year limit on exchanges between investment options, although it is not clear how the program is supposed to determine whether the transfer is made “to effectuate a distribution” – i.e. is there some implied limit on how long the transferred amount can remain in the cash option? The final regulations also exclude from the exchange limit the automatic rebalancing of the account assets to maintain the asset allocation level chosen when the account was established or by a subsequent investment direction.
- Payment of Administrative and Investment Fees not a Distribution. The final regulations provide that the payment from an ABLE account of administrative and investment fees charged by the ABLE program does not constitute a distribution for tax purposes. This provision may also be of interest to section 529 college savings programs, where the appropriate treatment of CDSCs and similar redemption or withdrawal charges has sometimes been a discussion topic.
- Post-Calendar Year Distributions. For purposes of matching qualified disability expenses with distributions received in a tax year, the final regulations permit the beneficiary to treat expenditures made in the first 60 days of the calendar year as made in the prior tax year. This provision may also be of interest to distributees from section 529 college savings programs.
- Post-Death Payments. The final regulations contain an unfortunate and problematic provision stating that “after the expiration of the applicable statute of limitations for filing Medicaid claims against the designated beneficiary’s estate, a qualified ABLE program may distribute the balance of the ABLE account to the successor designated beneficiary or, if none, to the deceased designated beneficiary’s estate.” In many instances, it may be unclear which states might have Medicaid claims against the designated beneficiary’s estate, and what the longest potentially applicable limitations period might be for any such claim. As the claim is against the beneficiary’s estate, it is unclear what function is served by forcing the account to remain open for an unclear but potentially lengthy time period versus permitting the program to distribute the balance to the beneficiary’s estate at any time after proof of the beneficiary’s death. The regulations also provide that a state law prohibiting the filing of a Medicaid claim against either the ABLE account or the designated beneficiary’s estate will not prevent that state’s program from being a qualified ABLE program, but it is unclear whether such a law also invalidates potential claims by other states and/or permits the distribution of an account balance prior to the expiration of the limitations period for other states with potential Medicaid claims.
The final regulations also clarify that an ABLE program may permit a change in the designated beneficiary of an ABLE account, made during the life of the designated beneficiary, to take effect upon the death of the designated beneficiary, but that the amount to be transferred pursuant to such a beneficiary designation is first subject to the payment of any qualified disability expenses incurred before the designated beneficiary’s death but not yet paid and to Medicaid recapture claims, which presumably means that no such successor beneficiary can make withdrawals from the account during any applicable limitations period for any potential Medicaid recapture claim.
- Gift and Transfer Tax Consequences. The final regulations clarify that neither gift tax nor generation-skipping transfer tax apply to transfers of an ABLE account by rollover, program to program transfer or change in beneficiary to another eligible individual who is a sibling or step-sibling of the beneficiary. In contrast to the approach under the proposed regulations, any other transfer is treated as a taxable gift or transfer of the entire account by the beneficiary. This approach eliminates the potential need for ABLE programs to track cumulative contributions and withdrawals made to or from an ABLE account by the beneficiary as opposed to other contributors.