Four things taxpayers need to know before opening an ABLE account

Potential tax consequences, heavy recordkeeping, and complications with other government benefits could surprise some families if they’re not prepared

By: Alison Flores  /  November 20, 2015

Editor’s note: The 2017 Tax Cuts and Jobs Act temporarily modified the contribution limit and added additional provisions for ABLE accounts, as noted in this article.

Individuals with disabilities and their families often face tough choices when it comes to providing for necessary housing, health care, education and social services. And financially planning for the future is even more difficult. Families must prepare to meet the lifetime needs of an individual with a disability, while navigating the eligibility requirements of government-sponsored programs.

In 2014, Congress passed the Stephen Beck, Jr. Achieving a Better Life Experience (ABLE) Act of 2014. This law allows states to create tax-advantaged savings accounts for individuals with disabilities. The individuals and their families can use the funds to pay for qualified expenses and save for the future.

ABLE accounts are similar to the popular “529” education savings accounts that families use to save tax-free for their children’s college education.

How ABLE accounts (529A accounts) work

More than half of all states are taking steps to allow individuals with disabilities to open ABLE accounts. To qualify to open an ABLE account, an individual:

  • Must have been younger than 26 at the onset of disability, and
  • Must have a medically determined physical or mental impairment that results in marked and severe functional limitations.

Here are some essential facts about ABLE accounts:

  • Family, friends, and the individual with disabilities can contribute to the ABLE account.
  • The account has an aggregate contribution limit of $15,000 per year ($14,000 in years before 2018).[1]
  • Earnings grow tax-free.
  • The account holder can take tax-free distributions to pay for qualified expenses.
  • Expenses must relate to the individual’s disability and help the individual maintain or improve his or her health, independence, or quality of life.
  • An ABLE account can be used simultaneously with a special needs trust.
  • If the account holder receives Medicaid benefits, any remaining ABLE account balance may have to be turned over to the state after the individual dies. This provision allows the state to recover amounts spent to provide Medicaid coverage.

Overall, ABLE accounts may be a win-win for families. However, families should understand the following potential complications to ensure they can successfully integrate ABLE accounts into their financial plans.

1. Families must classify expenses – and there are tax consequences for nonqualified expenses.

By law, qualified disability expenses are construed broadly. Expenses don’t have to be medically necessary to be a qualified expense. And, expenses may still be qualified even if they are useful to someone who doesn’t have a disability.

Making the connection. A smart phone could be considered a qualified disability expense for a child with autism if the phone provides for more effective and safe communication or navigation. On the other hand, movie tickets, which provide entertainment only, are probably not a qualified expense.

Account holders may conclude that just about any withdrawal could be qualified. However, for practical reasons, they should connect the potential expense with a tangible benefit for the account holder – and document how the expense will help the individual maintain or improve health, independence, and quality of life.

Taxing nonqualified withdrawals. If an ABLE account holder makes a withdrawal for a nonqualified expense, the amount is subject to a 10 percent additional tax, and the earnings associated with the nonqualified withdrawal are treated as taxable income. The account holder is responsible for reporting and paying the 10 percent additional tax on his or her tax return.

If the individual isn’t otherwise required to file a return, he or she may be able to file Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts, and send the tax payment without filing Form 1040.

2. Parents may lose the ability to claim the dependent exemption.

Parents know the benefit of claiming a dependent exemption on their tax returns.[2] A dependent exemption can open the door to lower tax rates and tax credits, such as the refundable Earned Income Tax Credit, the dependent care credit, and the Child Tax Credit.

One requirement a parent must meet to claim the dependent exemption for a qualifying child is that the child must not provide more than half of his or her own support. Note that a “child” may be an adult child with disabilities.

Determining who provided support. Determining who provided the child’s support can be complicated, because some types of income are considered provided by the child, even if the income is from a third party. For instance:

  • Distributions from an ABLE account used to pay support expenses of the child will be considered support provided by the child.
  • A child’s Social Security Survivors benefits or Social Security Disability Insurance (SSDI) benefits are considered support provided by the child if the funds are spent to support the child.

In contrast, Supplemental Security Income (SSI) benefits are considered support provided by a third party (a government agency).

When a child with disabilities receives support from multiple sources, parents need to track the total amount of support provided by the child, the parents, and third parties.

Shifting support. If parents shift from paying expenses out of their pocket to paying expenses out of an ABLE account, the child could technically end up providing more than half of his or her own support.

As a result, the parent would no longer qualify to claim the child as a dependent.

Parents and their tax advisors should evaluate levels of support to determine whether ABLE distributions will affect the parents’ ability to claim the dependent exemption.

3. ABLE account holders should be prepared to handle documentation requirements.

For individuals expecting to use an ABLE account on a frequent basis, the following documentation requirements will likely add an extra layer of complexity to everyday transactions.

Certifying the diagnosis. Individuals must certify their disability diagnosis under penalties of perjury before opening an ABLE account. Account holders are required to keep a copy of their signed physician’s diagnosis and provide information about their disability to the ABLE program or the IRS, upon request.

Account holders may have to periodically recertify their condition. If the condition changes so that the individual is no longer eligible for the program, the individual must notify the ABLE program.

Categorizing distributions. ABLE programs will not determine or track whether distributions are for qualified disability expenses. Account holders must categorize the distributions when filing their tax returns.

For tax purposes, ABLE account holders should keep receipts and other documentation (such as a contemporaneous log or spreadsheet) showing total qualified disability expenses.

Retaining documentation. The ABLE plan administrator will issue Form 5498-QA (reporting contributions) and Form 1099-QA (reporting distributions). Account holders need to keep those forms, receipts, and other documentation to determine whether distributions are taxable.[3]

4. There are two ways ABLE accounts could affect SSI benefits.

Distributions from an ABLE account and the account balance itself are generally disregarded for purposes of determining eligibility for federal means-tested programs, such as SSI and Medicaid. However, there are two notable exceptions.

Housing expenses. When an SSI recipient lives with someone rent-free, the arrangement is considered in-kind support and is treated as income. Receiving in-kind support can reduce the maximum SSI benefit by as much as one-third of the federal SSI benefit rate plus $20.

If account holders use ABLE funds to pay for housing expenses, the funds will be treated like in-kind support and will reduce the ABLE account holder’s monthly SSI benefits.

SSI resources. SSI resources include cash, bank accounts, stock, bonds, land, personal property, vehicles, deemed assets, and anything else that could be changed to cash and used for food or shelter.

At the beginning of the month, if an SSI recipient’s resources are worth more than $2,000 (the limit for most SSI recipients), then the individual’s SSI benefits will be effectively suspended for that month. That limit can be easy to reach considering the wide range of assets that count as resources.

When it comes to ABLE accounts, the good news for SSI recipients is that the first $100,000 in the account is not counted as an SSI resource. And because the maximum yearly contribution for an ABLE account is $15,000 ($14,000 for tax years before 2018), it could take more than seven years with no distributions for the ABLE account to reach $100,000.

If the ABLE account balance exceeds $100,000, the excess will be treated as an SSI resource. This could potentially cause SSI benefits to be suspended. However, if an individual’s ABLE account balance causes SSI benefits to be suspended, the account holder is still eligible for Medicaid.

Because of these two complications, SSI recipients will need to take special care to document withdrawals and monitor their ABLE account balance.

Know the effects

Many individuals with disabilities and their families will likely take advantage of the new ABLE accounts. These individuals and their tax advisors should also carefully examine the family’s specific situation to be prepared for any potential tax effects, documentation requirements, and complications with other government-sponsored benefits.

[1] Prior to the 2017 TCJA, a qualified ABLE program could not accept aggregate contributions from all contributors (other than rollovers from other accounts) that exceeded the annual gift tax exclusion amount ($14,000 for 2017, $15,000 for 2018). Under the TCJA, the contribution limit is temporarily increased for contributions made by the account’s designated beneficiary. Once the general contribution limitation is reached (equal to the annual gift tax exclusion amount), the designated beneficiary can contribute additional amounts up to the lesser of (a) the beneficiary’s compensation for that tax year, or (b) the federal poverty line based on a one-person household. For 2017, the federal poverty line for a one-person household is $12,060; this limit will apply to ABLE contributions in calendar year 2018. Rolled over amounts from QTPs (also known as 529 accounts) count toward the overall limitation. The new provision applies to contributions made after December 22, 2017 and before January 1, 2026.

[2] The 2017 TCJA temporarily suspends the exemption for dependents for tax years 2018 through 2025, however, the tests for whether a child qualifies the taxpayer for the earned income credit and dependent care credit remain intact. Additionally, the changes to the child tax credit do not impact this article. Thus, the support tests described in this section will still apply in determining eligibility for those credits.

[3] The 2017 TCJA requires that either the designated beneficiary, or another person acting on the beneficiary’s behalf, must maintain “adequate records” demonstrating compliance with the new overall contribution limitations.

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Author Name

Alison Flores

Alison Flores, JD, is a principal tax research analyst at The Tax Institute. Alison specializes in the Patient Protection and Affordable Care Act, same-sex marriage, tax preparer regulation, and individual income tax issues.

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