2017 National Conference on Special Needs Planning and Special Needs Trusts Interplay of Tax and Eligibility Rules in 529 Accounts and ABLE Accounts Stephen W. Dale, JD, LL.M
Interplay of Tax and Eligibility Rules in 529 and ABLE Accounts Many proponents of this new tool tout the fact that that this new tool is tax free in nature compared special needs trusts. Below is a common claim; While it is possible that a special needs trust could be subject to high tax rates, While funds in SNTs and ABLE accounts are both disregarded for means tested benefits like Medicaid and SSI, income from ABLE accounts is tax free while SNTs are taxed at high rates. with a minimal amount of planning, often a special needs trust will be a superior tax planning tool compared to an ABLE Account.
An Overview of the ABLE Act
An Overview of the ABLE Act Other key features: Contributions into an ABLE account could be made by any person; Contributions would not be tax deductible; Income earned by the accounts would not be taxed; Account withdrawals, including portions attributable to investment earnings generated by the account, for qualified expenses would not be taxable;
Qualified Disability Expenses Qualified disability expenses are any expenses made for the designated beneficiary related to their disability, including: 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. 5
Qualified Disability Expenses A Tale of 2 Administrative Agencies Many ABLE advocates have taken the position that ANY use of an ABLE Account based on the information in the next slide. Compare this with the Social Security Administration s position that the mere use of the word caregiver in a self settled trust makes the entire trust a resource because they take the harshest view possible
Qualified Disability Expenses (h) Qualified disability expenses (1) In general. Qualified disability expenses, as defined in 1.529A 1(b)(16), are expenses incurred that relate to the blindness or disability of the designated beneficiary of the ABLE account 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 related to the designated beneficiary's education, housing, transportation, employment training and support, assistive technology and related services, personal support services, health, prevention and wellness, financial management and administrative services, legal fees, expenses for oversight and monitoring, and funeral and burial expenses, as well as other expenses that may be identified from time to time in future guidance published in the Internal Revenue Bulletin. See 601.601(d)(2) of this chapter. Qualified disability expenses include basic living expenses and are not limited to items for which there is a medical necessity or which solely benefit a disabled individual. 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.
Penalties if Used for Non Qualified Expenses
Penalties if Used for Non Qualified Expenses Example Bob over a decade saves $50,000, and over that period the account earns $10,000 for a total of $60,000. If Bob were to use the $60,000 for a down payment on a home, no taxes would be due.
Penalties if Used for Non Qualified Expenses If instead Bob were to use $5,000 to pay for gambling, the $5,000 would be taxable, but how much would the hit be? To figure that out we need to look at a traditional 529 plan.
Exceptions to the Penalty Pule for a Traditional 529 Plan? No penalty is due if If the beneficiary dies or becomes disabled If the student decides to attend a U.S. Military Academy If the student receives a scholarship In all of these cases the earnings portion of the withdrawal will incur income tax.
Traditional 529 Plan and 10% Penalty The 10% additional tax doesn't apply to distributions. made because the designated beneficiary is disabled. A person is considered to be disabled if he or she shows proof that he or she can't do any substantial gainful activity because of his or her physical or mental condition. A physician must determine that his or her condition can be expected to result in death or to be of long continued and indefinite duration.
Earnings will also be subject to tax as ordinary income at your tax rate Non qualified withdrawals will transform a 529 plan into a taxable investment. 529 plans generally allow the custodian of the 529 Plan to direct the withdrawal to the beneficiary. If the contributor was able to deduct the original contribution on his or her state income tax return, the contributor will usually have to report additional state "recapture" income.
Tuition and fees Books Computers technology, related equipment and internet access Special needs equipment Some room and board expenses must be at least ½ time student Additional expenses of special needs beneficiaries: These include certain services and equipment that a special needs student would require, such as wheelchairs and transportation costs, which are generally considered a nonqualified expense. Qualified withdrawals
Taxable Earnings for Non Qualified Withdrawals. Use the following steps to figure the taxable part. Multiply the total distributed earnings shown on Form 1099 Q, box 2, by a fraction. The numerator (top part) is the adjusted qualified education expenses paid during the year and the denominator (bottom part) is the total amount distributed during the year. Subtract the amount figured in (1) from the total distributed earnings. The result is the amount the beneficiary must include in income. Report it on Form 1040 or Form 1040NR, line 21.
Taxable Earnings for Non Qualified Withdrawals. The tax form will be sent to either the participant (account owner) or beneficiary depending on the recipient of the distribution. Generally, the beneficiary is listed as the recipient if the distribution is made for the direct benefit of the beneficiary or to an eligible educational institution for the benefit of the beneficiary. The participant will be listed as the recipient on all other distributions.
Example 1 In 2009, Sara Clarke's parents opened a savings account for her with a QTP maintained by their state government. Over the years they contributed $18,000 to the account. The total balance in the account was $27,000 on the date the distribution was made.
Example 1 In the summer of 2016, Sara enrolled in college and had $8,300 of qualified education expenses for the rest of the year. She paid her college expenses from the following sources. Gift from parents $1,600 Partial tuition scholarship (tax free) 3,100 QTP distribution 5,300
Example 1 Before Sara can determine the taxable part of her QTP distribution, she must reduce her total qualified education expenses by any taxfree educational assistance. Total qualified education expenses $8,300 Minus: Tax free educational assistance 3,100 Equals: Adjusted qualified education expenses $5,200 Since the remaining expenses ($5,200) are less than the QTP distribution, part of the earnings will be taxable. Sara's Form 1099 Q shows that $950 of the QTP distribution is earnings.
Example 1 Sara figures the taxable part of the distributed earnings as follows. Sara must include $18 in income (Form 1040, line 21) as distributed QTP earnings not used for adjusted qualified education expenses.
What is an Eligible Education Institution? An eligible educational institution is any college, university, vocational school, or other post secondary educational institution eligible to participate in a student aid program administered by the U.S. Department of Education. It includes virtually all accredited public, nonprofit, and proprietary (privately owned profit making) post secondary institutions. You can look up schools using the Department of Education s federal school code database, or ask the school if it is eligible.
The ABLE Act and Taxes Compared to a Special Needs Trust 22
Income Taxes Comparison with a SNT Need to focus on all tax options One value of an ABLE Account is that it is tax free like a 529 plan Probably as simple as it gets A special needs trust can often qualify as a Qualified Disability Trust and many distributions are deductible at the beneficiaries tax level Requires tax return for trust and beneficiary 23
Qualified Disability Trusts From the Special Needs Alliance www.specialneedsalliance.org 24
Income Taxes Striking a Balance ABLE Account compared to Special Needs Trust If a 3rd party special needs trust is drafted as a Qualified Disability Trust It has a full $4,050 exemption in 2016, & all distributions from the Trust for the benefit of the beneficiary are taxed to the beneficiary, AND The beneficiary has his/her own, 2nd exemption of $4,050, & a standard deduction in 2016 of $6,300. A 3rd party special needs trust can shelter a total of $14,400 in 2016 of taxable income with a standard deduction Beneficiaries with large medical expenditures may be able to shelter more with itemized deductions. 25
Income Taxes Striking a Balance ABLE Account compared to Special Needs Trust An ABLE Account (s) with $100,000 (maximum not to lose SSI) would need to earn over 14% for any income tax benefit over a 3rd party SNT. Keep in mind the ABLE Account is subject to a Medicaid Payback. 26
Income Taxes Striking a Balance ABLE Account compared to Special Needs Trust To compare income taxes between an ABLE Account and a 3 rd party special needs trust for a benefits recipient receiving SSI and/or Medicaid it is important to understand the difference between benefits income and taxable income. 27
Income and Income
What is Income? Benefits income is not the same as taxable income This concept is often confused by Social Security and Medicaid workers you must be prepared to educate them about their own rules 29
Taxable Income For purposes of trusts and taxable income, distribution of income is either distribution directly to, or for the benefit of the beneficiary. 30
Benefits Income For purposes of needs based benefits, income is cash, or anything that can be used for food, or shelter, unless it is exempt. 31
Compliance Issues of 3 rd Party SNTs Where a trust is created by a third party for the benefit of someone other than the grantor the trust will be a separate taxpayer. The trust will have its own taxpayer identification number require annual state and federal fiduciary income tax returns. To the extent that distributions have been made to the beneficiary even inkind, the trust will carry out income to the beneficiary and a K 1 given to the beneficiary. The K 1 will report that income has been paid to the beneficiary and will include the beneficiary's social security number. 32
Benefits Income = Taxable Income Example If the Trustee of a Special Needs Trust pays the telephone bill of the beneficiary directly from a Special Needs Trust, the beneficiary has received a benefit and therefore has received taxable income to the extent it is made up of DNI (Distributable Net Income) In this example, the beneficiary did not receive any income for benefits purposes because the beneficiary did not receive cash, or food clothing or shelter. 33
Possible Deductible Expenses In addition to being able to deduct direct medical care, below is an example of other expenses that might be deductible; Special school instruction (which can include lodging, meals, transportation and other expenses not normally deductible). This deduction requires the school to focus on adaptive education for people with neurological or physical limitations. Home modifications required due to disability. Travel and registration costs for conferences and seminars if a doctor will write a letter explaining how the conference will help deal with his/her special needs, the costs may be deductible as a medical expense. Attendant care at work. If your child has a job that requires attendant care, the portion of those costs not covered by other programs may be deductible.
Example Appreciated Stock to Trust with Annual Contribution to ABLE Account Archie has a nephew named Michael who is on SSI and Medicaid and he would like to make a gift of $100,000 of appreciated stock with a basis of $10,000 into Michaels ABLE Account. Michael is fully competent and can establish his ABLE Account as well as mange it. The problem is twofold, the ABLE Account can only accept $14,000 a year, and to make the gifts directly into the ABLE Account Archie would need to sell the stocks and realize the gain, and distribute the after tax funds to the ABLE Account. If Archie gifts the stock to Michael to sell then he would lose eligibility to his SSI and Medicaid the calendar month he receives the stock, and would remain ineligible until his resources drop below $2,000.
Example Appreciated Stock to Trust with Annual Contribution to ABLE Account Archie creates an irrevocable 3 rd party special needs trust with Gloria as the trustee. Archie transfers the stock into Michael s special needs trust and then Gloria sells $14,000 a year of the stock and transfers the funds into the ABLE Account. Each year the trust is eligible for the $4,050 qualified disability trust exemption, and the gain realized from the gain of the stock will likely be less than the gain realized from the sale.
Example Appreciated Stock to Trust with Annual Contribution to ABLE Account From page 4 of Form 1041 ES https://www.irs.gov/pub/irs access/f1041es_accessible.pdf
The ABLE Act Gift and Estate Taxes 38
The ABLE Act Gift and Estate Taxes ABLE Accounts have as one of it s benefits that funds gifted to an ABLE Account are exempt from gift and estate taxes. This segment will explore gift and estate taxes and the ABLE Act and help the viewer determining when gift or estate taxes are an issue and when they are not. 39
Gift and Estate Tax Benefit for the 0.14 % The Center on Budget and Policy Priorities estimates that only the richest 0.14 percent of Americans pay any estate tax. The gift and estate tax is a boogie man for most of us. Beware some states like Illinois have estate taxes. Texas and California does not we are Pick Up States 40
Gift Tax Gift for the.14% The problem with a special needs trust is that by its nature gifts to the a special needs trust are not considered a completed gift. But here is the reality of the situation. 41
Gift Tax Gift for the.14% Let s say you were to make a gift into your child s special needs trust which was properly drafted for estate tax purposes. Because the trust is not a completed gift, you can t use your annual $14,000 federal gift exclusion, you will need to use part of your $5,500,000 lifetime exclusion. 42
The ABLE Act and Estate Taxes If you pass away in 2016 you can pass up to $5,500,000 to anyone you like, including your child s special needs trust, without paying one cent of gift or estate tax. If you were to give $50,000 to your child s special needs trust right now, you would still have a coupon allowing you to give another $5,450,000 tax free during your lifetime or upon your death. 43
When Might the Gift or Estate Tax Exemption for ABLE Accounts Matter The vast majority of Americans are not affected by gift and estate taxes under todays laws. When analyzing whether this is a situation one needs to look at 2 levels of the gift. The effect on the giver The effect on the receiver 44
Example A Disability Carole Tiny Tim has a disability that began before the age of 26, he is now 30 and his parents Bob and Emily have established an ABLE Account for him, as well as an irrevocable 3 rd party special needs trust. 45
Example A Disability Carole Uncle Ebinezer wants to make a gift of $14,000 a year for 10 years for Tiny. Uncle Ebinezer has a large estate worth more than $6,000,000. 46
Example A Disability Carole If he makes the gift to the special needs trust and made no other gifts during his lifetime he would only be able to leave $5, 360,000 estate tax free ($5,500,000 less $140,000) if he died in 2026. This effectively would cost his estate about $60,000 in estate taxes. This assumes no cost of living increase for the gift or estate tax exemption. 47
Example A Disability Carole If he were to make the gift to Tiny s ABLE Account the gift would be exempt from being counted for gift and estate taxes and his $5,500,000 gift and estate tax exemption remains intact. The ABLE Account would be subject to a lien when Tiny dies for any Medicaid used from the time the account was established 48
Example A Disability Carole Uncle Charles wants to match Uncle Ebinezer s generosity he wants to make a series of gifts of $14,000 a year to benefit Tiny totaling $140,000 by 2026. Charles has an estate less than $1,000,000 and is not likely to have an estate tax when he passes away. 49
Example A Disability Carole He is not concerned about gift of estate taxes because it is very unlikely his estate when he passes will come even close to $5,500,000, and makes his gift directly to Tiny s special needs trust. 50
The Effect on the Giver As we demonstrated making a gift that is not complete merely uses part of one s gift and estate tax coupon. For most of us there is little or no risk of actually paying any estate tax at all. 51
2017 National Conference on Special Needs Planning and Special Needs Trusts Interplay of Tax and Eligibility Rules in 529 Accounts and ABLE Accounts Stephen W. Dale, JD, LL.M