The Impact of the Foreign Account Tax Compliance Act (FATCA) of 2010
Breathes there the man with soul so dead, who never to himself hath said, “This is my own, my native land.” - Edward Everett Hale, “The Man Without a Country”
Poetic and patriotic words, but the reality of today is that many U.S. citizens don’t feel this way about their native land. In 2015, 4,279 U.S. persons relinquished or renounced their U.S. citizenship, a record-breaking amount. Many analysts project that the total number of renunciations or relinquishments in 2016 will exceed the 2015 mark. To put these numbers in perspective, less than 300 people renounced their U.S. citizenship in 2006.
Looking at statistics like these, you may ask yourself: “Why are so many people giving up U.S. citizenship?” And possibly, “Is this something I should consider?”
The Foreign Account Tax Compliance Act (FATCA) of 2010 and other U.S. tax reporting regulations may have something to do with why this is happening.
A simplified explanation of the FATCA legislation is as follows:
- It is primarily aimed at preventing tax evasion by U.S. taxpayers through the use of non-U.S. financial institutions and offshore investments.
- Foreign financial institutions are required to identify accounts held by U.S. persons and report account information to the IRS. Absent this information, they are required to withhold U.S. tax on U.S. source income paid and may decline account opening or terminate services.
Furthermore, the U.S. tax system is based on citizenship. A U.S. citizen pays tax on their worldwide income no matter what country they live in.
Beyond the tax compliance burden, the financial institution impact of the FATCA legislation has significantly impacted U.S. citizens living abroad. Rather than attempt to comply with FATCA reporting requirements, many foreign financial institutions are simply refusing to open or hold accounts for U.S. persons.
To alleviate the financial hardship and tax compliance burden, many U.S. citizens living abroad have decided not to maintain their U.S. citizenship. U.S. citizenship can be terminated through renunciation. A formal renunciation of U.S. citizenship must be made in a foreign state, generally at a U.S. consulate, and there are several State Department forms to file along with a processing fee.
In addition to the paperwork and fees, the exit tax under Internal Revenue Code Sec. 877A may apply. Generally speaking, in order to avoid the exit tax you must:
- be current with U.S. tax filings for the past 5 years,
- have had annual U.S. tax liabilities below $160,000 for those 5 years, and
- a net worth of less than $2,000,000.
If you find yourself in the situation where you are considering renunciation of your U.S. citizenship, there are planning opportunities and compliance requirements that must be considered. Contact Freed Maxick's International Expatriate Tax Services professionals to discuss your specific situation, or call to speak with an individual directly at 716.847.2651.View full article
Did your company develop any new products for the year? Make significant enhancements to products or processes? If you’re in financial management in any way in your company, you owe it to yourself and your firm to investigate if you qualify for the Research & Development (R&D) Tax Credit.
If you rely on the hard sciences or use technology in your business to create or improve products or processes, you might be able to reduce your federal taxes by a portion of the related costs incurred.
Investigating your eligibility for the credit includes an initial meeting with an R&D credit expert. What should you prepare for your initial meeting? Expect to be able to provide the following:
Access to Key Personnel Who Were or Are Involved in the R&D Activities
This might be one person or multiple individuals depending on your company size. In bigger companies, a team approach can often foster a better discussion, bringing ideas together and identifying other areas where one or more individuals in the company might be engaged in R&D activities.
Your key personnel must be available for meetings and interviews, and should also be able to identify who performed R&D-type work during the year and be able to assist in quantifying their time spent in this work. The identification should include both internal resources (employees) and external resources (outside contractors).
We have had great success with three to five attendees in these meetings with our clients, often one person from finance and others from the R&D activities.
Internal Documentation Concerning Your R&D Activities
Any contemporaneous documentation that monitors the activities qualifying as research activities will help to support the claim for the R&D credit. The more you can share the better—it’s less documentation that we the consultants have to do, and it will reduce the time R&D personnel spend with us on interviews and in other meetings. Examples might include blueprints or marketing materials, project write ups, status reports, modifications, etc. Detail highlighting unique features of your R&D is also generally very helpful. A product catalog with only pictures won’t be sufficient enough to stand on its own.
We understand that you probably won’t have all of this information at the initial meeting, but the more you have the better. As the R&D study progresses, we will work with company personnel to complete the information.
Your documentation should include financial information. Wages (box 1 of Form W-2) is usually the most important part of your potential R&D credit financial information. This includes wages paid to employees directly involved in R&D and employees in direct supervision or support of R&D.
Recording of your R&D activities to separate accounts is helpful. For example, bifurcating R&D material and supplies (property eligible for depreciation is excluded) and non-R&D materials and supplies saves time and effort at year’s end when calculating the credit.
The same point holds true regarding separate accounts for outside contractors for work in any of the four parts. In addition, copies of contracts with outside contractors showing who retains rights is important. As this can be a significant expenditure for many companies, copies of your larger contracts also help at initial meetings.
If you use a job-time tracking system, codes to signify R&D work vs. non-R&D work will assist in determining the project list and qualifying costs at the end of the year. If you don’t use a job-coding system, each eligible employee should keep a list of projects that may qualify for the R&D credit. (Some companies keep a simple Word document to track monthly R&D-related financials.)
If you find you need to retrofit your internal R&D documentation, you can begin to go back and build the records with a list of projects that your teams worked on that you believe are R&D. You will also need a list of employees in R&D with reasonable estimates of how much time they spent on the R&D projects, along with any other materials or outside contractor costs.
After our initial meeting all parties should practice timely follow up to questions, within a week generally. There must also be full disclosure of activities, especially work performed within the U.S. versus outside of the U.S. Only the former can qualify for the R&D credit.
Talk to our experts about your business' potential to claim the R&D credit today.View full article
Avoid potential tax ramifications in both the U.S. and Canada.
The United States has some mechanical rules for determining if one will be considered a resident for tax purposes.
Two Ways You Could Be a U.S. Resident
First, if you receive a Green Card, you will be granted the privilege of residing permanently in the U.S. as an immigrant. This will continue until either you surrender your Green Card or immigration authorities revoke it. As long as you hold a Green Card, you are required to file U.S. resident tax returns.
The second qualifying condition is if you meet the Substantial Presence Test. This is basically a 183-day of presence in the U.S. test—however, it's cumulative. You are considered a resident if you are physically present in the U.S. for at least 31 days in the current year, and the sum of the days in the current year plus 1/3 of the days physically present during the first preceding year, plus 1/6 of the days present in the second preceding year exceeds 183 days. (There are certain situations that allow an exemption of days for students, those in transit, commuters, and days spent for medical purposes.)
You must file a Form 8840 or Form 8843 and either attach it to your 1040NR or you may file it alone. These forms will exempt a non-U.S. citizen who meets the substantial presence test from being treated as a resident. They cannot be used by a Green Card holder.
There are also Treaty Tie Breaking Rules. Under Article IV of the U.S./Canada Treaty, there are several steps that you can follow to establish that even though you are present in the U.S. for over the required number of days, you actually have a closer connection to Canada. You must file a Form 8833 and disclose your position.
If it is determined that you are a resident of the U.S. for tax purposes, you will be taxed on Worldwide Income, regardless of where it is earned. You will also be required to file any of the Foreign Reporting Forms required of U.S. persons, such as FBARs, and Forms 8938, 5471, 8865, 8621, and 3520, to name a few.
If you are determined to be a non-resident, you are taxed on U.S. Source Income only. However, if you are taking a Treaty Position to be taxed as a non-resident, you are still required to file all of the reporting forms as named above.
Canada also has established consequences for being out of the country for too long. The Entry-Exit Initiative was due to be implemented June 30, 2014. This does not have a temporary stay at the moment. Under the Initiative, travelers will be required to swipe their passports upon entering and leaving each country. Canada and the US will share this information. Both countries remain dedicated to full implementation of the Initiative.
When fully implemented, this Initiative would allow both countries to be able to track, in real-time, the number of days actually spent in each country. All days are counted in this total, including days for work, vacation, and day trips for shopping or entertainment.
Once a Canadian resident loses his resident status, he is deemed to have disposed of his assets, which may generate a large tax bill. They may also risk the loss of the entitlement to Provincial Health Care. The time period out of the country depends on your Province of Residency.
In addition to being deemed a U.S. Resident for Income Tax purposes, a person's estate could also become liable to U.S. Estate tax.
A Word to the Wise
Use extreme caution on counting the number of days of presence in the U.S. Generally, snowbirds should not extend their time past 120 days per year. Under the cumulative test, 120 days consistently will bring you to 180 days over a three year period. You do not want to risk consequences from either country by exceeding this number.
Contact Freed Maxick's International Corporate Tax Services professionals to discuss your specific situation and avoid unexpected tax liabilities, or call to speak with an individual directly at 716.847.2651.View full article
The complexity of state and local sales and use tax is a problem in every state and for many businesses. Each jurisdiction has a different rule on the taxability and exemption of a particular product or service. For instance, downloaded computer software (that isn’t customized) is considered taxable in New York, but not taxable in California. Payroll services are subject to sales tax in Texas as a data processing service, but this service is not considered taxable in Pennsylvania or New York.
It continues to be a growing problem in an ecommerce world for businesses, especially small businesses, to stay compliant with each state’s regulations and to identify overpaying sales tax. In addition to the complexity of sales and use tax, states continue to broaden the taxability of transactions and audit businesses in order to raise more revenue. As such, businesses are likely to err on the side of caution and pay unnecessary sales tax on purchases or charge customers who are exempt. A company should evaluate the complexity and volume of their sales and use tax transactions to determine if there’s a remote possibility that the company is overpaying sales tax.
Reverse Sales Tax Audit
A reverse sales tax audit is a thorough analysis of a business in order to identify the overpayment of sales and use tax. A state and local sales tax consultant will evaluate your company’s business operations, fixed assets, and how you are paying and charging sales and use tax.
Generally, the first step is an evaluation of the purchasing function within your business in order to obtain an understanding of how purchases are being made and approved. Once the consultant has analyzed the business processes and purchasing methods, a sample of paid invoices will be reviewed for sales tax that was charged on exempt items and for the incorrect sales tax rate that may have been applied. Once a quantitative analysis has been completed, the appropriate documentation and information will be delivered to the state or vendors to recover the overpaid sales tax.
It’s also imperative to have an analysis performed on invoices to your customers. In today’s competitive global market, the ultimate decision of a customer could be based on the price of your product or service. Therefore, it’s vital for a business to know who they are selling to and whether the customer is subject to sales tax in their jurisdiction. Generally, a similar approach in reviewing the purchasing functions would be used on the company’s sales functions.
If you’ve had a reverse sales tax audit performed in the past, opportunities may still exist. State tax laws and exemptions are always changing and these changes could be overlooked by your company. In addition, having a reverse sales tax audit performed in conjunction with a major capital project underway can save tax dollars promptly by avoiding the payment of sales tax on purchases of equipment, supplies, etc. that could be exempt.
If your business engages in manufacturing activities or purchases and sells across multiple jurisdictions, you should discuss a reverse sales tax audit with a Freed Maxick professional from the SALT team.View full article
What you need to know as a nonresident who sells U.S. real property interests
If you are selling a piece of U.S. real estate, you may have a tax withholding obligation to the purchaser. The FIRPTA rules require that buyers of U.S. real property know the residency status of whoever is selling the property for reasons explained below.
FIRPTA requires that a purchaser of U.S. real property withhold tax on the gross sale price if the seller is a non-U.S. person. Real property for these purposes is either a piece of real estate or a corporation that holds real estate. A non-U.S. person for this purpose includes all foreign persons and foreign entities selling or transferring property located in the U.S. Any withholding tax owed (including interest) that isn’t remitted becomes a liability of the purchaser.
FIRPTA Withholding Rate Increase
As of February 2016, the FIRPTA withholding tax rate has increased to 15% from the previous rate of 10%. The tax is calculated based on the gross sales price with no consideration for the actual gain or loss. As a result, even on a loss transaction, foreign real property sellers are looking at the potential of a 15% tax withholding from the gross proceeds.
As an example, assume (as a foreign person) you sold a piece of real estate on June 1st for $1,000,000. The purchaser would be obligated to withhold $150,000 of the sale price and remit this to the IRS. This is true regardless of what your basis in the property was at the time of the sale. However, it is possible to request a reduced rate of withholding in advance of the closing to reduce or possibly eliminate this withholding. This can save a substantial amount of money, as any tax that isn’t owed but is withheld would not be available for refund until the following year upon filing a tax return.
There is a process by which you can apply for an exemption from or reduction to this mandatory withholding. Form 8288-B can be filed on behalf of the seller. As long as this form is filed by the date of closing, the purchaser will not be required to remit the withholding tax until notified the form has been processed by the IRS.
- Any purchaser of a U.S. Real Property Interest (USRPI) should be aware of the seller’s U.S. residency status.
- If you are a foreign seller of USRPI, the purchaser will withhold and remit 15% at settlement unless you apply for a withholding exemption.
- There are exceptions from the withholding rules. For example, if the gross sales price is $300,000 or less and the purchaser intends to use the property as a residence, there is no withholding required.
- All of this is in an effort to reduce the amount of withholding up front prior to filing of the tax return by the seller.
We at Freed Maxick have vast experience with these and other international matters. Please contact us if you have any questions.View full article
Avoid Unintended Results from Complex New Rules for Intercorporate Debt
In April 2016, the Treasury Department and the IRS issued proposed regulations under Sec. 385. If the proposed regulations are finalized, they will change the way that corporate groups treat intercompany debt. Issued along with guidance on corporate inversions, the new proposed Sec. 385 regulations target transactions that increase debt between related parties where there is no new investment in the U.S.
Following a corporate inversion or a foreign takeover of a U.S. company, a U.S. subsidiary can issue debt to its foreign parent which in turn transfers the debt to a foreign affiliate located in a low-tax jurisdiction. The U.S. subsidiary will deduct the interest expense at a higher tax rate than the tax rate paid on the interest income received by the foreign affiliate. The foreign affiliate may even implement tax strategies to avoid paying any tax on the interest income.
The new proposed regulations will make it more difficult for companies to engage in transactions described above as well as impact the U.S. tax treatment of cross-border loans between affiliated members of a multi-national enterprise, loans between commonly controlled U.S. corporations not filing a consolidated tax return, and loans between members of brother-sister U.S. consolidated return groups. The new proposed regulations will not impact loans between members of a single consolidated return group.
The new proposed regulations will do the following:
- Impose new documentation and reporting requirements that must be complied with on a timely basis (defined in the new proposed regulations). If the requirements are not met, the purported debt instrument will be characterized as stock for U.S. tax purposes. A reasonable cause exception applies.
- Allow the IRS to treat a debt instrument issued between members of a modified expanded group as part debt and part stock to the extent dictated by the relevant facts and circumstances. A modified expanded group is based on the affiliated group principles of Sec. 1504(a) modified with a 50% ownership requirement with the common parent and includes domestic and foreign corporations, RICs, REITs, S corporations, partnerships, trusts and estates, and individuals that own at least 50% of the stock or interests in a modified expanded group member.
- Require recharacterization of certain debt instruments to equity. Debt instruments issued in the following situations will be recast as stock:
Debt issued by a corporation to a related corporate shareholder as a distribution
Debt issued in a two-step version of the corporate distribution where a U.S. subsidiary borrows cash from a related company and pays a cash dividend to its foreign parent
Debt issued by a corporation in exchange for stock of an affiliate, e.g. the repurchase of shares for a note or the purchase of affiliate shares for a note in what would otherwise be a Sec. 304 transaction
Certain debt issued as part of an internal asset reorganization if the instrument is received by a corporate transferor that is a modified expanded group member with respect to its transferor corporation stock. The definition of an expanded group member is derived from the affiliated group rules of Sec. 1504(a) and includes foreign and domestic corporations related by at least 80% (vote or value) direct or indirect common parent ownership. Note that an expanded group for these purposes is different than a modified expanded group mentioned above in the “part debt and part stock” rule.
Exceptions to the Rule
There are certain exceptions to the application of the new proposed regulations. The exceptions are provided for small companies that are not publicly traded, groups with less than $50 million of intercompany debt, and for routine distributions such as the distribution of current year earnings and profits.
The new proposed regulations apply to debt instruments issued or deemed issued after April 4, 2016. Intercompany debt instruments that are subject to recharacterization will continue to be treated as debt for 90 days after the issuance of final regulations. Thereafter, these debt instruments will be considered to be equity. Debt instruments issued before April 5, 2016 are grandfathered, but will be subject to the final regulations if they are significantly modified after April 4, 2016.
The new proposed regulations under Sec. 385 are complex and require careful analysis. Taxpayers should make sure they understand the impact of these new rules on all intercorporate debt transactions so that they don’t end up with unintended results. Contact us to discuss your specific situation.View full article
The Research and Development (R&D) Tax Credit, recently made permanent, can be a financial boon as you work to improve cash flow in your business. As we've discussed in previous posts, if you rely on the hard sciences or use technology in your business to create or improve products or processes, you might be able to reduce your federal taxes by a portion of the qualified costs incurred.
A four-part test can help you determine if your company’s activities qualify for the R&D credit.
#1: Permitted Purposes
To qualify for the R&D credit, the activity must relate to a new or improved business component’s function, performance, reliability, quality, or composition. You don’t necessarily have to discover an innovation or advancement that’s new to your industry, only what may be innovative or new to you and your company’s processes or products.
#2: Technological in Nature
The activity performed must fundamentally rely on principles of physical sciences, biological sciences, computer science, or engineering. For example, if you’re in food production, simply adding more salt to your product won’t necessarily qualify—but a method based in hard sciences to enhance your product’s flavor might, as would similar methods designed to keep food fresher longer.
#3: Elimination of Uncertainty
The activity must be intended to discover information to eliminate uncertainty concerning the capability or method for developing or improving a product or process, or the appropriateness of the product design.
#4: Process of Experimentation
The qualifying activities must constitute the process of experimentation involving: simulation; evaluation of alternatives; confirmation of hypotheses through trial and error; testing and/or modeling; or refining or discarding of hypotheses.
Beyond definitions stipulated by the four-part test, examples of activities that might qualify for the credit include those to advance the design of an existing product or process, or those to correct significant design defects or obtain significant cost reductions or enhanced function. Costs of design, construction, and testing of pre-production prototypes and models can also qualify.
Let’s say you’re a manufacturing firm developing eyewear and you want to increase productivity 10% to 15%. Your costs for doing an evaluation of the raw materials, considering new molds, and determining such factors as the proper heating and cooling temperatures for that raw material and/or molds may qualify for the R&D credit.
Similarly, if you have a product run by software, costs of developing new software to make that product more reliable and more efficient might quality for the credit. If you’re an architectural or engineering firm, costs of researching and incorporating green technology might qualify.
Other activities potentially qualifying for the credit: conceptual formulation, design, and testing of possible product or process alternatives; launch activities involving a new component or process; or design time, tool design and testing, prototype building, and similar activities. Also:
- Engineering efforts to develop new plant processes or technical redesign of an existing plant layout that result in substantial production gains;
- Efforts to solve production problems where there was uncertainty as to the best solution; and
- Design and testing involved in improving the configuration or altering the composition of an existing product or process to increase efficiency or decrease cost.
Some activities do not qualify for the R&D credit, including funded research (for example, funded by a government grant), ordinary testing and inspection, research done outside the U.S., reverse engineering (unless such engineering involves an enhancement, in which case a percentage of your R&D costs may qualify for the credit), adaptation of an existing business component to a particular customer’s requirement or need (for example, adapting a computer program you sell to a particular customer’s requirement), or research with a non-functional focus such as improving or changing style, taste, or cosmetic changes.
Also not qualifying: research after commercial production; management studies or activities; and efficiency or consumer surveys.
Qualified costs include wages paid to employees directly involved with, in direct supervision of, and in direct support of the R&D; materials and supplies used and consumed in the process; and work performed by outside contractors in any of the four parts of the test qualify as long as you retain substantial rights in what the contractors do.
The R&D credit can apply to companies in many industries. We can help you explore the potential of the R&D credit for current and prior open tax years and talk about how your efforts to grow your business could generate cash savings on your federal (and state) tax returns. Contact us to learn more.View full article
The Public Company Accounting Oversight Board (PCAOB) recently issued and the Securities and Exchange Commission approved rules that will soon require audit firms to disclose engagement partner names as well as other firms that participated in the audit. These rules were created to increase transparency and accountability among audit firms and allow investors access to information on which individual partner was responsible for the audit work in a given year.
To help firms understand the implication of these rules, here is a summary of the new guidance below.
Under the new rules, auditors will be required to file a new PCAOB Form AP, Auditor Reporting of Certain Audit Participants, for all public company audits. The following information must be disclosed on the form:
- Name of the engagement partner and their “Partner ID” (a unique ten-digit identifier that will now need to be assigned by the firm to each partner who serves as engagement partner for issuer audits)
- For other accounting firms participating in the audit for which the responsibility for the audit is not divided:
5 percent or greater participation: The name, city and state (or, if outside the United States, the city and country) of the headquarters’ office, and, when applicable, the Firm ID, and the percentage of total audit hours attributable to each other accounting firm;
Less than 5 percent participation: The number of other accounting firms that participated in the audit whose individual participation was less than 5 percent of total audit hours, and the aggregate percentage of total audit hours of such firms; and
- For other accounting firms participating in the audit for which the responsibility for the audit is divided:
The name, and when applicable, the Firm ID; city and state (or if outside the United States, the city and country) of the office of the other accounting firm that issued the other auditor’s report; and the magnitude of the portion of the financial statements audited by the other accounting firm.
Effective Dates: Phased Approach
Firms will need to start naming engagement partners on the new Form AP, which is available now on the PCAOB website, starting with audits issued on or after Jan. 31, 2017. Other audit firms must be named on the form with the required additional information for public company audits issued on or after June 30, 2017. Form AP must be filed directly with the PCAOB no more than 35 days after the date the auditor’s report is first included in a document filed with the SEC.
Who is Affected?
This change impacts both the accounting firms providing the service and the companies retaining them. The additional filing provides additional transparency to stockholders and others involved with the company.
If you are interested in learning how this new filing will impact your company or to discuss your 10K filings, Freed Maxick wants to help. Contact us for more information.View full article
We see it happening more and more. U.S. companies are sending their employees into foreign (host) countries on temporary but at times lengthy business assignments. Employees are willingly accepting these offers, not realizing the tax exposure risks that these opportunities could present. In order to mitigate some of these risks, we see payroll departments turning to something known in the industry as “shadow payroll.”
So What is Shadow Payroll?
Shadow payroll is a mechanism used to assist with the reporting and tax withholding obligations in a host country for an employee who is remaining on his or her home country’s payroll system while on assignment in the host country. The payroll in the host country will “shadow” what is being reported in the home country, but the employee will not receive any compensation from the host country.
The purpose of the shadow payroll in the host country is to remain in compliance with jurisdictional payroll tax laws and remit any taxes or forms that need to be filed in the host country while allowing the employee to stay on the U.S. employer's retirement, stock option, and other benefit plans.
Typical example of when to use shadow payroll
A U.S. person travels on a long-term work assignment to Canada. Since the U.S. taxes income on a worldwide basis, the employee and employer must stay compliant in the U.S. while also taking into consideration any tax requirements in Canada. The employer will typically setup a shadow payroll for Canada for that U.S. person as if he or she were being compensated in Canada in order to calculate the payroll tax requirements for the wages earned in Canada. The employee will continue to be paid wages solely from the U.S. payroll system and all U.S. payroll tax requirements will also continue to be satisfied. To further complicate the matter, there may be additional state or provincial tax filing obligations that need to be considered.
While employers are concerned with keeping in compliance with all appropriate tax requirements when implementing a shadow payroll system, employees face the concern that they may be double taxed on their wages that are taxable in both the U.S. and host countries. It is important to mention that there may be foreign tax credits, exclusions, as well as tax treaties benefits available to the employees between the U.S. and certain other countries to help mediate the potential of double taxation.
If you are a U.S. company that is looking to send employees on a foreign assignment or an employee looking to avoid the risk of double taxation, please contact us.View full article
Families of Those with Disabilities Can Save on Qualified Expenses
Section 529 of the Internal Revenue Code has been around nearly 20 years now, so most taxpayers with children are aware of the advantages of investing in a “529 Plan” for tax-advantaged savings for future college costs. Though enacted as part of the federal tax code, these plans are administered by states, and many states, such as New York, even offer a tax deduction for investing in them.
A new version of 529 plans is now becoming available. On December 19, 2014, the Achieving a Better Life Experience (ABLE) Act was enacted as section 529A of the Internal Revenue Code. The ABLE Act authorized states to establish programs allowing taxpayers to save and invest funds for disability-related expenses of eligible individuals (defined below).
Even though federally enacted in 2014, it takes states time to adopt the Act and get their programs up and running. The New York ABLE Act became effective on April 1, 2016, but is not yet available for taxpayers to invest in. New York expects the program to launch by year end 2016.
529-ABLE accounts are designed to support individuals with disabilities. To be eligible, an individual must have a disabling condition or blindness that occurred before reaching the age of 26. An account is established in the name of the beneficiary (the disabled person) or his/her parent, legal guardian, or representative, and while there is no deduction for contributions to the plan, earnings on funds invested grow tax-free as long as used on qualified disability expenses of the beneficiary. Qualified expenses include the following:
- Employment training and support
- Assistive technology and personal support services
- Health, prevention, and wellness
- Financial management
- Legal fees
- Funeral and burial expenses
- Other expenses approved by the Treasury
It is not necessary that the beneficiary currently be under the age of 26. Any age may be a beneficiary, as long as the condition was diagnosed prior to reaching age 26. When opening an account, a certification process must be completed to ensure the beneficiary qualifies as an eligible individual.
Even though the account is held in the name of the beneficiary, the intention is to supplement any Federal/State aid the beneficiary may be receiving, such as Medicaid, SSI, and even private insurance. This is important, because the funds in a 529-ABLE plan are generally not included in total assets for federal means-tested benefits. However, if the plan balance exceeds $100,000, distributions to pay for housing will be considered for SSI.
A beneficiary is allowed to have only one ABLE account, and there is a cap on the amount contributed each year, equal to the annual gift tax exclusion (currently $14,000). Excess contributions will be subject to a 6% excise tax, and any distribution made for non-qualifying expenses will be subject to a 10% penalty. Each state will set its own limits on how much can accumulate in the plan. In New York, the plan balance is limited to $375,000. Once the account balance reaches $375,000, earnings will still grow tax-free, but no additional contributions may be made until the account balance falls below that level.
Upon death of the beneficiary, the remaining funds will be used to first pay any outstanding qualified expenses. Any excess remaining will be repaid to the state, as creditor, for reimbursement of any expenses paid by Medicaid for the beneficiary from the date the account was established. Finally, any remaining funds will be distributed to the deceased’s estate or a designated beneficiary. Any portion of that balance that represents earnings on the account will be taxed as investment earnings.
The passage of the ABLE Act provides a long overdue tax-advantaged way for families of those with disabilities to save for the costs of caring for those individuals. For help navigating what the Act can mean for your family, contact us.View full article