IRS’s Proposed Section 529A Regulations for ABLE Programs: A Mixed Bag
The IRS today published, right on deadline, its proposed regulations relating to Section 529A state-sponsored “qualified ABLE programs,” under which tax-advantaged investment accounts may be established to fund future “qualified disability expenses” of eligible disabled individuals.
The regulations are detailed and this posting will not attempt to summarize them in their entirety. Rather, a few provisions of the proposed regulations are highlighted below, along with some initial reactions.
Applicability: The regulations are issued as proposed regulations, and therefore technically are not in effect. Comments are due within 90 days of the publication date in the Federal Register, and a public hearing on the regulations will be held on October 14, 2015. The preamble to the regulations indicates taxpayers and state programs can rely on the proposed regulations until final regulations are adopted. Somewhat perplexingly, the preamble also indicates that the final regulations will be applicable to taxable years beginning after December 31, 2014. To the extent this suggests that the final regulations will be applicable retroactively, it appears inconsistent with the promise made in IRS Notice 2015-18 that “[t]he Treasury Department and the IRS intend to provide transition relief with regard to necessary changes to ensure that the state programs and accounts meet the requirements in the [regulatory] guidance, including providing sufficient time after issuance of the guidance in order for changes to be implemented.” One hopes that the IRS will clarify that such a transition period will be provided after final regulations are adopted, versus retroactive application of such final regulations to any taxpayer or program that has not complied with the proposed regulations; otherwise, programs and taxpayers may be forced to comply with the proposed regulations even though they are not legally effective.
Who May Establish an ABLE Account: Section 529A requires that the tax owner of any ABLE account be the eligible disabled beneficiary. The proposed regulations provide that if the beneficiary cannot establish the account on his or her own, it may be established on the disabled beneficiary’s behalf by an agent under power of attorney or, if there is no such agent, by a parent or legal guardian. This narrows the field of potential relatives who can establish an ABLE account for a disabled individual, and eliminates the ability of a non-parent to establish such an account unless he/she has a power of attorney or is a legal guardian. It also appears to preclude, or at least not acknowledge, the use of custodial accounts, such as an UTMA account, which is surprising.
Eligible individual determination: The proposed regulations are disappointing from the perspective of administrative ease and clarity on the key question of what documentation is required to establish and maintain an ABLE account. As an initial matter, the regulations cast the responsibility for verifying eligibility status on the state programs. The regulations indicate that a “qualified ABLE program must specify the documentation that an individual must provide, both at the time an ABLE account is established for that individual and thereafter, in order to ensure that the designated beneficiary of the ABLE account is, and continues to be, an eligible individual.”
There are two statutory methods for an individual to qualify as eligible for an ABLE account. One is the filing of a disability certification with the Secretary of the Treasury that certifies that the individual has a qualifying disability or is blind and that such disability or blindness occurred before the individual’s 26th birthday; the certification must include a physician-signed diagnosis of the relevant disability or blindness. The proposed regulations provide that “a disability certification will be deemed to be filed with the Secretary once the qualified ABLE program has received the disability certification.” The regulations are silent on what level of diligence the state program must engage in, if any, to establish that papers that purport to be a disability certification comply with the substantive requirements (including type of diagnosis) of the regulatory definition of a disability certification. This provision is likely to be perceived as problematic by state programs and to provoke a high level of pushback during the comment period from state administrators who believe that eligibility status should be between the taxpayer and the federal government, not something that a state has any role in verifying.
An alternative statutory basis for ABLE account eligibility is eligibility for Social Security Act benefits based on blindness or disability that occurred before the individual’s 26th birthday. The proposed regulations are silent on a state’s role in verifying this type of eligibility. The preamble to the proposed regulations states that “for example, a qualified ABLE program could require the individual to provide a copy of a benefit verification letter from the Social Security Administration and allow the individual to certify, under penalties of perjury, that the blindness or disability occurred before [the individual’ 26th birthday.” While this non-regulatory example appears potentially less onerous in terms of state verification responsibility than the unclear role of a state program under the proposed regulations upon its receipt of a disability certification, it still raises some potentially thorny questions, such as, for example, whether a program is required to make a competency determination before relying upon a declaration signed by a disabled individual.
The proposed regulations’ treatment of eligibility determinations for years following the year in which an account is established is even vaguer. The regulations provide that “a qualified ABLE program may choose different methods of ensuring a designated beneficiary’s status as an eligible individual and may impose different periodic recertification requirements for different types of impairments.” The proposed regulations suggest that, with respect to the frequency of annual recertifications, ABLE programs “may take into consideration whether an impairment is incurable and, if so, the likelihood that a cure may be found in the future,” a suggestion that casts state officials entrusted with administering a financing program in the combined role of physicians and Nostradamus. The proposed regulations further suggest that a state program may establish a sliding scale of frequency of recertification based on the type of impairment. Less fantastically, the regulations suggest that “[i]f the qualified ABLE program imposes an enforceable obligation on the designated beneficiary or other person with signature authority over the ABLE account to promptly report changes in the designated beneficiary’s condition that would result in the designated beneficiary’s failing to satisfy the definition of eligible individual, the program also may provide that a certification is valid until the end of the taxable year in which the change in the designated beneficiary’s condition occurred.” This type of presumption that an individual continues to be eligible unless the program receives notice to the contrary is on the right track, but what constitutes an “enforceable obligation” by a disabled individual or his or her agent, parent or guardian to report a change in condition is anybody’s guess.
Residency requirement: Consistent with Section 529A, the proposed regulations require that, at the time an ABLE account is established, the designated beneficiary must be a resident of the state offering the program or a resident of a state without a program that has contracted with such other state for purposes of making its residents eligible to participate in such program. The proposed regulations state that for purposes of such residency requirement residency is determined under the law of the designated beneficiary’s state of residence. There is no guidance on whether any proof of residency is required or whether a state may rely on a certification made by or on behalf of the beneficiary as his or her state of residency. The proposed regulations confirm that a change in the beneficiary’s state of residency after an ABLE account is established does not affect the beneficiary’s right to continue to use the applicable ABLE account.
Cumulative contributions limit: The proposed regulations affirm that for purposes of the statutory cumulative contributions limit, which equals the cumulative limit imposed by the applicable state under its Section 529 qualified tuition program, it is permissible for the program to refuse additional contributions that would cause the limit to be exceeded (versus tracking the lifetime contributions to the account, irespective of investment gains or losses.) This methodology is used by many Section 529 programs but had not been officially blessed by the IRS in that context.
Qualified disability expenses: The proposed regulations provide a hoped-for generous definition of “qualified disability expenses” which states that such term “includes basic living expenses and [is] not limited to items for which there is a medical necessity or which solely benefit a disabled individual.”
State role regarding qualified disability expenses: Quite unexpectedly, the proposed regulations state that “[a] qualified ABLE program must establish safeguards to distinguish between distributions used for the payment of qualified disability expenses and other distributions, and to permit the identification of amounts distributed for housing expenses as that term is defined for purposes of the Supplemental Security Income program.” This purported duty of state programs to monitor the use of distributions from ABLE accounts has no basis in the Section 529A statutory language, is inconsistent with the manner in which similar language in Section 529 has been construed by the IRS, and is at odds with other provisions of the proposed regulations that provide for qualified distribution expenses to be determined by the taxpayer on an annual basis, not by tracing of particular distributions to particular expenses. This provision is highly problematic from a practical as well as a legal perspective and will likely provoke a high level of pushback during the comment period.
Medicaid lien: The proposed regulations state that an ABLE program “must provide that a portion or all of the balance remaining in an ABLE account of a deceased designated beneficiary must be distributed to a State that files a claim against the designated beneficiary or the ABLE account itself with respect to benefits provided to the designated beneficiary under the State’s Medicaid plan … after … the date on which the ABLE account, or any ABLE account from which amounts were rolled over or transferred to the ABLE account of the same designated beneficiary, was opened….” The proposed regulations provide no guidance on whether the program must keep an ABLE account open for a particular period of time following a designated beneficiary’s death, or whether the beneficiary’s estate can direct closure of the account at any time and distribution to the estate of all amounts remaining in the account.
Reporting: The proposed regulations include detailed reporting requirements for ABLE programs, including references to new forms to be used by state programs in reporting data regarding the establishment of ABLE accounts (Form 5498-QA) and in reporting distribution data (Form 1099-QA). The preamble to the proposed regulations also references a Congressional report “that States should work with the Commissioner of Social Security to identify data elements for the monthly reports [required to be submitted to the Commissioner of Social Security], including the type of qualified disability expenses.” As noted above, the suggestion that States will have a duty to report types of qualified disability expenses is both legally and practically problematic.