The IRS's recently-published proposed regulations for Section 529A qualified ABLE programs have taken some wind out of the sails of state program administrators and potential program managers who had hoped for regulations that hewed closer to the requirements in effect for qualified tuition programs under Section 529, on which Section 529A was based. Some state officials and would-be program managers are evaluating whether cost-effective ABLE programs can be launched given what, at first blush, appear to be substantially greater administrative burdens imposed on state programs by the proposed ABLE regulations.
The hesitation provoked by the proposed regulations is understandable when one compares the IRS's proposed administrative requirements to those applicable to Section 529 programs. Section 529 programs are not required to check whether an account owner is eligible to open an account, are not required to check on an annual basis whether the account owner's status has changed, and are not required to inquire into or track the use of account withdrawals. (As originally enacted, Section 529 did make programs responsible for determining whether distributions were qualified or unqualified, a requirement so unworkable that Congress amended Section 529 to eliminate it and make the recipient responsible for documenting the use of the distribution upon inquiry by the IRS.)
In marked contrast, the proposed ABLE regulations would require that ABLE programs do all of the above.
The resulting cost issue for ABLE programs and their potential customers is obvious. Due to statutory restrictions under Section 529A, annual contributions to ABLE accounts cannot exceed an inflation-indexed $14,000; Section 529 accounts have no such limit. Moreover, each state's 529A program is limited to that state's residents, unless another state elects to have its residents use the other state's program instead of establishing its own program. Section 529 programs, on the other hand, can gather assets from the entire nation. If one adds to the substantially smaller projected amount of a particular ABLE program's assets under management the expenses associated with the increased staff and systems programming necessitated by the additional verification and recordkeeping requirements imposed by the proposed regulations, the math is simple: greater expenses divided into fewer assets equals substantially higher program expenses to be recovered from program participants, and therefore reduced investment returns for the future expenses of disabled individuals.
A fair reading of the ABLE Act is that Congress intended the IRS, not the state programs, to be the watchdog that would ensure that ABLE programs are used by the disabled and for qualified disability expenses, and intended the Social Security Administration to determine whether ABLE account distributions are used for housing or unqualified expenses (in which case they are factored into the disabled individual's eligibility for SSI benefits, whereas ABLE account distributions for non-housing qualified disability expenses are disregarded.) But in an era where federal agency resources, particularly the IRS's, are stretched, the proposed regulations have been drafted to effectively shift that responsibility, and the attendant costs, to the state programs.
The question the state programs and their potential contractors are struggling with is what exactly these unexpected and unwelcome responsibilities entail, and how much expense has been shifted from the federal government to the disabled community. If the well-intentioned and long-sought ABLE Act is to achieve its objective, it will be in the interest of Congress, the IRS and the disability community, not just the state programs, to ensure that the administrative burden is reduced to the minimum necessary to make these programs function as intended.
The proposed regulations are not technically binding before they are finalized, and it is possible that, following the current 90 day comment period, the IRS will issue final regulations that lighten some of the proposed burden on ABLE program administrators. But whether and when any more program-friendly final regulations will be issued is unknown, and the disability community deserves to have access to ABLE programs sooner than the indefinite future. Unless and until the IRS, by advance notice or other clarification, provides better answers, individual states that wish to go forward with ABLE programs in advance of final regulations will need to reach a comfort level that they can comply with the IRS's unexpected views on what a state must do to maintain its ABLE program's beneficial tax status without making the pass-through costs of operating an ABLE program so expensive as to potentially outweigh the tax benefit.
A consensus on what practices are sufficient to comply with the proposed regulations without saddling ABLE programs with impracticable and expensive procedures will take some time to evolve. Here is an initial perspective:
The proposed regulations state 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."
For those account owners who are ABLE-eligible because they are eligible for SSI or SSDI disability benefits, the preamble to the proposed regulations suggests that "[f] or 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 date on which the individual attained age 26." This suggestion may be workable if the Social Security Administration will provide such benefit verification letters with respect to the then-current tax year in short order upon request by an individual wishing to open an ABLE account. Otherwise, if an individual can only provide a prior year benefit verification letter to the state program, states will need to decide whether, in connection with an account opening, they can rely upon the account owner's certification, under penalties of perjury, that such eligibility status has not changed since the year in which the benefit verification letter submitted to the program was issued by the Social Security Administration.
As to those account owners who are ABLE-eligible under Section 529A because they file an eligibility certification and a physician diagnosis with the Secretary of Treasury, the preamble to the proposed regulations states that "[w]hile 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 section 529A might not be as easy to establish." The proposed regulations state that "a disability certification will be deemed to be filed with the Secretary [of Treasury] once the qualified ABLE program has received the disability certification", which "deemed" filing, according to the preamble, is designed "to facilitate an eligible individual's ability to establish an ABLE account without undue delay."
Taking the IRS at its word that the shifting of the certification filing from the Treasury, as specified in the statute, to the states, as specified in the proposed regulations, is designed to "facilitate" account-opening "without delay," it seems sensible to interpret the regulations as requiring a state to confirm no more than that a certification facially stating what the proposed regulations require has been signed or e-signed by the account owner (or his or her agent, parent or guardian), and is accompanied by a physician's signed or e-signed letter facially providing the diagnosis on which the account owner's certification relies.
Based on the proposed regulations, it appears that the certification filed with the ABLE program by or on behalf of the account owner must be signed or e-signed under pains and penalties of perjury and should state something along the following lines:
"(i)(A) I have the following medically determinable physical or mental impairment: _____________________________. This impairment results in marked and severe functional limitations (as defined below), and—
(1) Can be expected to result in death; or
(2) Has lasted or can be expected to last for a continuous period of not less than 12 months; or
(B) I am blind (within the meaning of section 1614(a)(2) of the Social Security Act);
(ii) Such blindness or disability occurred before the date of my 26th birthday.
For purposes of this certification, "marked and severe functional limitations" means the standard of disability in the Social Security Act for children claiming Supplemental Security Income for the Aged, Blind, and Disabled (SSI) benefits based on disability (see 20 CFR 416.906). Specifically, this is a level of severity that meets, medically equals, or functionally equals the severity of any listing in appendix 1 of subpart P of 20 CFR part 404, but without regard to age. (See 20 CFR 416.906, 416.924 and 416.926a.) Such phrase also includes any impairment or standard of disability identified in future guidance published in the Internal Revenue Bulletin. Consistent with the regulations of the Social Security Administration, the level of severity is determined by taking into account the effect of the individual's prescribed treatment. (See 20 CFR 416.930.) Conditions listed in the "List of Compassionate Allowances Conditions" maintained by the Social Security Administration (at www.socialsecurity.gov/compassionateallowances/conditions.htm) are deemed to meet the requirements of clause (i) of this certification."
Based on the proposed regulations, it appears that the physician's diagnosis accompanying the account owner's certification must be signed or e-signed by the physician and should state:
"I hereby certify that I am a physician meeting the criteria of section 1861(r)(1) of the Social Security Act (42 U.S.C. 1395x(r)). I further certify that I have examined ____________ and that, based on my examination, I have determined that s/he has the following physical or mental impairment: ________________________."
The ABLE program administrator would need to determine that the account owner's certification has been signed or e-signed in the name of the account owner or by someone who has certified that he or she is the account owner's agent, parent or guardian, and that the diagnosis inserted in the blank of such certification matches the diagnosis in the blank of the physician's diagnosis, and that the physician's diagnosis is signed or e-signed.
It should be noted that draft tax instructions for Form 5498-QA released by the IRS require a program to report to the IRS annually, for each account and by code number, "the type of disability for which the designated beneficiary is receiving ABLE qualifying benefits." The code menu on the draft IRS instructions is:
Code 1 - Developmental Disorders: Autistic Spectrum Disorder, Asperger's Disorder, Developmental Delays and Learning Disabilities
Code 2 – Intellectual Disability: "may be reported as mild, moderate or severe intellectual disability"
Code 3 – Psychiatric Disorders: Schizophrenia, Major depressive disorder, Post-traumatic stress disorder (PTSD), Anorexia nervosa, Attention deficit/hyperactivity disorder (AD/HD), Bipolar disorder
Code 4 – Nervous Disorders: Blindness; Deafness; Cerebral Palsy, Muscular Dystrophy, Spina Bifida, Juvenile-onset Huntington's disease, Multiple sclerosis, Severe sensoneural hearing loss, Congenital cataracts
Code 5 – Congenital anomalies: Chromosomal abnormalities, including Down Syndrome, Osteogenesis imperfecta, Xeroderma pigmentosum, Spinal muscular atrophy, Fragile X syndrome, Edwards syndrome
Code 6 – Respiratory disorders: Cystic Fibrosis
Code 7 – Other: includes Tetralogy of Fallot, Hypoplastic left heart syndrome, End-stage liver disease, Juvenile-onset rheumatoid arthritis, Sickle cell disease, Hemophilia, and any other disability not listed under Codes 1-6.
The tax instructions state that "the ... information will only be used for aggregate reporting purposes as required by law."
The notion that a state ABLE program established to provide investment accounts should have any role in determining which of the above panoply of medical conditions, if any, an account applicant suffers from sends off all sorts of alarm bells for many of those involved in structuring such programs. This proposed requirement can only be met by the relevant state program, if it can be met at all, by coding into the Form 5498 whatever condition the applicant and the physician have filled in on the forms submitted when the account is established. Even that will require coding additional fields into the ABLE programs' operating system and may require staff to translate the conditions specified in the application materials into the appropriate code. And in the case of applicants who establish ABLE eligibility via eligibility for SSI or SSDI benefits, the diagnosis may not be apparent from the benefits letter submitted as proof. This is an unwarranted level of complexity and expense for the questionable benefit of then adding up all the painstakingly gathered disability codes into an aggregate report that has nothing to do with the ABLE program's operations. But unless and until the IRS signals relief from this proposed requirement, ABLE programs that wish to go forward will need to design systems capable of generating such coding, at the expense of ABLE program participants.
2) Annual recertification:
As noted above, the proposed regulations require that programs specify the documentation that must be provided after an account is opened to establish the account owner's continued disabled status. According to the proposed regulations, "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 include several impractical suggestions on compliance that presume that the state program has expertise on the likely length of particular disabilities (see the above list) and the likelihood of a cure being found for particular disabilities. However, the proposed regulations also state: "If 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."
It seems likely that most states will follow this suggestion and include a requirement of such notice of change in disability status in the participation agreement or similar agreement executed or adopted by an account owner when the account is opened. There is no reason to think that such a covenant by the account owner is any less "enforceable" than any other contractual agreement by the account owner, but as the proposed regulations are unclear on what the IRS means by "enforceable", it may be prudent to state that the IRS is a third-party beneficiary of that particular covenant, so that the IRS can enforce it as it sees fit in the event it is breached by the account owner.
3) Tracking distributions:
The most perplexing provision in the proposed regulations states 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 the amounts distributed for housing expenses as that term is defined for purposes of the Supplemental Security Income program of the Social Security Administration."
The proposed regulations also provide that "[i]f the total amount distributed from an ABLE account to or for the benefit of the designated beneficiary of that ABLE account during his or her taxable year does not exceed the qualified disability expenses of the designated beneficiary for that year, no amount distributed is includible in the gross income of the designated beneficiary for that year." Accordingly, for tax purposes, particular distributions are not made for qualified or unqualified purposes, or for housing purposes; instead, distributions may be requested at any point in the year, and then are simply compared in the aggregate to the account owner's aggregate qualified disability expenses for the applicable tax year.
Because the account owner is not required for tax purposes to link a particular withdrawal to a particular expenditure, it is mystifying how the IRS and the Social Security Administration think programs can discharge this tracking and reporting duty. No guidance whatsoever is provided on this point in the proposed regulations. Given that some portion of the disabled community is expected to use ABLE accounts as transaction accounts, a requirement that states demand and examine invoices or receipts for each requested distribution, and determine in each case whether the amount is qualified or non-qualified and, if qualified, relates to housing, would substantially delay distributions and impose staffing requirements on programs or their contractors that would dramatically increase the expense ratios of ABLE investments. A distribution verification requirement is exactly what was amended out of Section 529 by Congress, and Congress did not reintroduce it statutorily when it enacted Section 529A.
This distribution tracking requirement, if not eliminated or clarified promptly by the IRS and the Social Security Administration, risks delaying or stopping many potential ABLE programs, particularly if interpreted to require anything more from the state program than a "check the box" section on distribution request forms. States that are willing to proceed pending further clarification of this troubling element of the proposed regulations will likely provide account owners with distribution forms that ask that each requested distribution be broken down into subtotals relating to housing expenses, other qualified disability expenses, and unqualified expenses, all as determined and certified by the account owner under pains and penalties of perjury. The state programs will make the required monthly reports to the Social Security Administration on the basis of such certifications. Even the tracking of these subtotals and the related systems programming requirements will impose requirements on ABLE programs, and resulting expenses for ABLE program investors, that Section 529 programs are not burdened with and that are properly left between the Social Security Administration and those account owners receiving federal disability benefits.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.