By LEN WEISER-VARON

The Stephen Beck, Jr., Achieving a Better Life Experience Act of 2014 (ABLE Act), one of the few recent examples of bipartisan cooperation on a new category of tax and budget expenditure, is both well-intentioned in its principles and cumbersome in its details, another example of the proposition that a camel is a horse designed by a committee.  Recent and imminent actions by regulators at the United States Treasury and Social Security Administration evidence commendable dedication to sanding off some of the rougher edges of the ABLE legislation.  Such beneficial regulatory guidance reflects, in both substance and timing,  extraordinary attention by federal regulators to concerns raised by the state instrumentalities charged with establishing and administering ABLE programs and by disability advocacy groups that have pushed and prodded to make this new form of savings and investment account for individuals with severe disabilities a reality.  Aided by this healthy cooperation among regulators, administrators and beneficiaries and the developments described below, ABLE programs should become available in various states during 2016.

  •  Treasury Issues Favorable Advance Guidance for ABLE Program Administrators

Treasury issued proposed ABLE regulations on June 29, 2015, has received comments on those regulations and is expected to publish a revised version of such regulations as final regulations when feasible taking into account the regulatory process.  It is anticipated that some ABLE programs will be launched in advance of the issuance of such final regulations.  However, the National Association of State Treasurers’ College Savings Plan Network (CSPN) (which now includes entities involved in establishing Section 529A ABLE programs as well as  entities involved with Section 529 college savings programs) had requested advance guidance from Treasury on three points which, if not resolved by Treasury prior to its issuance of final regulations, could have delayed the structuring and launching of ABLE programs.  On November 20, 2015, Treasury issued Notice 2015-81, providing such expedited advance guidance and agreeing with CSPN’s requested resolution on each of the three points.

In particular. Notice 2015-81 affirms that, notwithstanding contrary language in the proposed regulations, the final regulations under Internal Revenue Code Section 529A will provide that:

  1. An ABLE program will not be required to track or report the use of distributions from an ABLE account.  Although an ABLE program will need to report the amount of distributions and allocate distribution amounts to earnings or return of basis, it will not need to determine the amount of each distribution used by the account beneficiary for, respectively, non-housing qualified disability expenses,  housing-related qualified disability expenses, or expenses that are not qualified disability expenses.  The ABLE account beneficiary, however, will need to maintain records sufficient to allocate ABLE account distributions to qualified or non-qualified expenditures for tax purposes, and, in certain instances as discussed below, to  qualified non-housing, qualified housing or nonqualified expenditures for Supplemental Security Income (SSI) eligibility purposes.
  2. An ABLE program will not be required to request the social security number or other tax identification number (TIN) of each third party contributor to an ABLE account at the time a contribution is made, if (as will be the case for most if not all programs) the program has a system in place to identify and reject excess contributions and excess aggregate contributions before they are deposited into an ABLE account. (If, however, an excess contribution or excess aggregate contribution is deposited into an ABLE account, the qualified ABLE program will be required to request the TIN of the contributor making the excess contribution or excess aggregate contribution.)
  3. In instances where the ABLE statute conditions ABLE eligibility on the filing of a signed physician’s diagnosis of the relevant disability, an ABLE program will not be required to collect or review such physician diagnosis, but can rely on a certification under penalties of perjury that the individual (or the individual’s agent under a power of attorney or a parent or legal guardian of the individual) has the signed physician’s diagnosis, and that the signed diagnosis will be retained and provided to the ABLE program or the IRS upon request.  Notice 2015-81 indicates that the final regulations will “likely” require that such certification include the name and address of the diagnosing physician and the date of the diagnosis, and “may also provide” that the certification “may” include information provided by the physician as to the “categorization of the disability” that could determine, under the particular state’s program, the appropriate frequency of required recertification.   (The need for annual recertification is another sensitive topic from the perspective of state ABLE program administrators, but the proposed regulations suggest that the final regulations will be sufficiently flexible that states that do not wish to require annual recertification will not be obligated to do so.)  The Notice helpfully states that if the final regulations require more as to the signed physician diagnosis than the certification of its possession by the provider of the certification and that the diagnosis will be retained and provided to the ABLE program or the IRS upon request, such additional requirements will not apply to certifications obtained by an ABLE program prior to the effective date of such final regulations.

Appreciation is due to Catherine Hughes at Treasury and to Terri Harris and Sean Barnett at IRS for their attentiveness and responsiveness to the request for such advance guidance.

  •  Social Security Administration Expected to Issue Favorable Guidance for ABLE Beneficiaries

For SSI benefit recipients, the beneficial treatment of ABLE account balances and distributions for SSI eligibility purposes is at least as important as their beneficial tax treatment.  Although the Social Security Administration has yet to issue formal guidance clarifying that treatment, it is expected to do so through an update to its Program Operations Manual System (POMS) before the end of 2015.  Based on informal communications with and by SSA officials, the treatment is expected to facilitate the use of ABLE accounts without adverse impact on SSI benefits.

Broadly speaking, SSI benefits eligibility is reduced and may be eliminated to the extent the applicable beneficiary has countable assets or countable income in excess of extremely modest amounts.  However, the ABLE Act provides that ABLE account balances are disregarded for SSI purposes except to the extent they exceed $100,000, and that ABLE account distributions for qualified disability expenses also are disregarded except in the case of distributions for housing expenses.

The statutory exclusions leave some ambiguity as to the timing and methodology of determinations that particular ABLE account distributions are excluded from SSI benefits determinations.  The treatment expected to be described in the POMS update is as follows:  Distributions of ABLE account balances of $100,000 or less will not constitute countable income, as such amounts already are owned by the SSI beneficiary at the time of the distribution. Distributions from ABLE accounts will not constitute countable assets if expended within the same month as the distribution is received by the beneficiary from the account, irrespective of the nature of the expenditure.  Distributions from ABLE accounts that are not expended within the same month as the distribution is received by the beneficiary will not be counted as a countable asset if ultimately expended on a qualified disability expense that is not a housing expense.  An ABLE account distribution expended on a housing expense or non-qualified expense in a later month than the month in which the distribution is received may be treated retroactively as a countable asset in all months between distribution and expenditure, potentially requiring the beneficiary to refund SSI benefits received during that period.

Bottom line:  An SSI recipient should not experience any adverse impact from the existence of an ABLE account as long as the account balance is kept at or below $100,000 (probably measured as of each month end), and, subject to confirmation when the relevant POMS update is published by SSA, as long as distributions from the ABLE account are expended in the month of receipt.  Expending ABLE account distributions in a month subsequent to the month of receipt will not produce an adverse result if the expenditure is a qualified disability expense that is not a housing expense, but may create some risk to SSI benefits if the documentation of the expenditure is inadequate or the classification of the expenditure is debatable.

By LEN WEISER-VARON

On December 16, 2014 the U.S. Senate approved the Achieving a Better Life Experience (“ABLE”) legislation previously approved by the House, authorizing state-sponsored tax-exempt savings programs for disability-related expenses. President Obama is expected to sign the legislation (which is part of the “tax-extenders” bill) before the year is out. Pursuant to the legislation, states may establish ABLE programs under which individuals can set up ABLE accounts in which earnings can accumulate and be distributed on a tax-free basis to pay for the expenses of a disabled beneficiary.

The new Section 529A of the Internal Revenue Code, into which the ABLE provisions will be codified, is modeled on the immediately preceding section, pursuant to which “Section 529” college savings programs have been launched nationwide. The perceived inequity of the existence of tax-favored savings accounts permitting parents and others to save for children’s higher education costs but not for the future expenses of children with disabilities produced an increasingly rare consensus in Congress on the enactment of this new tax benefit for individuals.  As stated by one of the legislation’s co-sponsors: “No longer would individuals with disabilities have to stand aside and watch others use IRS-sanctioned tools to lay the groundwork for a brighter future.”

Although the desire to level the playing field, taxwise, for families saving for individuals with disabilities propelled the ABLE statute through a difficult legislative environment, Section 529A is being enacted under budget-neutral requirements requiring offsetting budget cuts to balance out the projected new tax expenditures. This explains various constraints on the funding of Section 529A ABLE accounts that are not present in the case of Section 529 college savings accounts, which were originally authorized as tax-deferred accounts in 1996 and made tax-exempt in 2001.

The substantive provisions of the ABLE legislation, similarities and differences between ABLE programs and Section 529 programs, and additional steps that will be required at the state level before ABLE accounts become available to those anxious to provide for the future of disabled beneficiaries are outlined below.

I.  ABLE Programs and Accounts

a. Residency Requirement

Although the legislation authorizes the federal tax benefits associated with ABLE accounts effective January 1, 2015, such accounts only can be accessed through a state-administered program authorized under state legislation. Unlike Section 529 programs, which have no residency limits and therefore can operate as nationwide programs in which states compete with each other based on state tax incentives and the attractiveness of the investment managers and investment options provided by each program, an ABLE account only may be opened in the program established by the state in which the disabled beneficiary resides, or, if such state has not established an ABLE program, in the program of another state with which the beneficiary’s state of residence has contracted for the purposes of providing its residents access to an ABLE program.

b. Single Account Requirement

Also in contrast to Section 529, only one ABLE account per beneficiary is permitted. Accordingly, once an ABLE account is established for a particular beneficiary, a subsequent ABLE account established by the same or a different person for the same beneficiary will not qualify for the ABLE tax benefits. An exception is contemplated for account rollovers to a different state’s program if a beneficiary changes his or her state of residence, if the beneficiary is changed to another beneficiary residing in a different state or, presumably, if the state of the beneficiary’s residence establishes its own ABLE program after having initially contracted out its ABLE program to another state.

c.  Contribution Limits

The maximum amount that can be contributed to an ABLE account is the same generous maximum contribution limit applicable to Section 529 college savings accounts; in fact, the statute specifies that the ABLE account limit is the limit established by the applicable state for its Section 529 program. Although Section 529 precludes excessive contributions, it does not provide a specific dollar limit, and the formulas used by each state to determine contribution limits to that state’s program vary; many states currently have per beneficiary limits in the range between $300,000 and $400,000.

There are two significant aspects, however, in which the funding of ABLE accounts is restricted relative to the funding of college savings accounts.  First, unlike Section 529, Section 529A imposes an annual per account funding limit equal to the annual gift tax exclusion (currently $14,000 per year), which means that it would take several decades of steady annual contributions to build up to the permissible per beneficiary limit.

Second, the per beneficiary limit imposed under Section 529 is measured against accounts opened in a particular state’s programs; because Section 529 does not restrict the number of states in which accounts for a particular beneficiary can be established, as a practical matter there is no limit on the amount that can be contributed to Section 529 accounts for a single beneficiary. Because Section 529A limits ABLE accounts for a particular beneficiary to a single account in a single state, both the annual and the lifetime contribution limits for an ABLE account beneficiary are meaningful limits.

Because these limits, particularly the annual limit, put ABLE accounts at a disadvantage relative to Section 529 accounts, and ABLE programs at a disadvantage relative to Section 529 programs due to the likelihood of a smaller asset base against which program administrative expenses can be spread, future pressure on Congress to loosen the annual limit on ABLE account contributions can be anticipated.

d. Account Ownership Requirements

Another structural difference between ABLE accounts and Section 529 college savings accounts is that the ABLE legislation defines “designated beneficiary” as “the eligible individual who established an ABLE account and is the owner of the account”, whereas Section  529 permits the account owner to be a different individual (or entity) than the beneficiary. One of the psychologically attractive features of Section  529 accounts is that a parent or other individual can be the account owner, set aside money for the beneficiary and treat the money as transferred to the beneficiary for gift and estate tax purposes, while maintaining total control of the account, including the right, if necessary, to apply the money for the account owner’s purposes, rather than the beneficiary’s (subject to payment of income taxes and a 10% tax penalty on the withdrawn account earnings.) This unique deemed gift arrangement under Section 529 has given the IRS headaches due to concerns about potential circumvention of transfer taxes.

Perhaps in response to such concerns, the ABLE legislation eliminates for ABLE accounts the distinction between the account owner and the beneficiary, and thus requires an irrevocable transfer to the beneficiary by the funder(s) of the ABLE account. In addition, ABLE accounts are ineligible for the 5-year accelerated gifting provision applicable to 529 accounts.

The requirement that an ABLE beneficiary be the account owner is puzzling, particularly given that  many beneficiaries are likely to be minors, and that some of the beneficiaries may not have contracting capacity even when they are adults. This suggests that ABLE accounts may need to be established as UTMA or UGMA accounts or in other forms of individual or corporate custodianship for the account owner/beneficiary.

A related peculiarity is that, as is the case with Section 529 accounts, the ABLE statute permits changes in an account’s designated beneficiary to another “member of the family”, although for ABLE accounts that term is limited to siblings and step-siblings of the beneficiary, whereas for Section 529 accounts the term includes a much wider menu of relatives. Given that an ABLE beneficiary is also required to be the account owner, it appears that a change in account beneficiary also would require a change in account ownership. Moreover, given that such a change would require direction from the account owner, any such change would seem to require direction by the original account owner/beneficiary or by some other individual with power of attorney for the original account owner/beneficiary. This is an area in which regulatory or other guidance is likely to be required.

An additional peculiarity is that the ABLE legislation attempts to provide some bankruptcy protection to ABLE accounts, as is provided for Section 529 accounts.  However, the language protecting ABLE accounts protects ABLE account assets “only if the designated beneficiary of such account was a child, stepchild, grandchild, or stepgrandchild of the debtor.” This language makes sense in the context of Section 529, where the “debtor”/account owner typically is a different individual than the beneficiary. In the case of an ABLE account, where the beneficiary is required to be the account owner, the language offers no protection for a bankruptcy by the account owner/beneficiary, as, notwithstanding some well-known song lyrics, the beneficiary cannot be his or her own child or grandchild.

e. Eligibility Requirements

Under the ABLE legislation, the beneficiary of an ABLE account must be an “eligible individual” at the time the account is established, at the time of any contribution to the account and at the time of a distribution for qualified disability expenses. Eligibility is required to be redetermined for each tax year. To be eligible, an individual must have been determined to be disabled prior to age 26.

There are two ways of satisfying the disability determination. First, an individual meets the eligibility requirement if during the applicable tax year the individual is entitled to Social Security Act benefits based on blindness or disability that occurred before the individual reached age 26. Alternatively, the eligibility requirement can be satisfied if (i) a certification is filed on behalf of the individual for the applicable tax year with the Treasury Secretary, certifying that the individual is blind or has a physical or mental impairment which results in severe functional limitations and which has lasted or is expected to last for a continuous period of at least 12 months or can be expected to result in death, (ii) the certification attests that such blindness or disability occurred prior to age 26 and (iii) the certification includes a diagnosis of the relevant impairment signed by a qualified physician.

The ABLE legislation does not specify what happens if an individual is eligible at the time an account is established and at the time of contributions and distributions, but there are intervening years in which the annual eligibility determination was not made or documented. Regulatory guidance will be needed on whether there is a deemed termination of the ABLE account in the first year in which eligibility is not determined, or a less draconian result.

f. Qualified Disability Expenses

As with Section 529 accounts, earnings in an ABLE account build up on a federally tax-free basis, and distributed earnings remain tax-free to the extent they do not exceed the beneficiary’s qualified expenses in the applicable tax year. For an ABLE account, “qualified disability expenses” is defined broadly as “any expenses related to the eligible individual’s blindness or disability which are made for the benefit of an eligible individual” and includes expenses for education, housing, transportation, employment training and support, assistive technology and personal support services, health, prevention and wellness, financial management and administrative services, legal fees, oversight and monitoring, funeral and burial and other expenses approved by the Treasury Secretary.

The earnings portion of distributions from an ABLE account that exceed an eligible beneficiary’s qualified disability expenses is subject to federal income tax and, unless the distribution follows the beneficiary’s death, a 10% additional tax.

g.  Investment Direction

The ABLE legislation permits an account beneficiary to direct the investment of contributions to the account twice a year.  (The ABLE legislation also amends Section 529 to permit such twice a year investment direction for Section 529 college savings accounts.) Assuming that the IRS interprets the ABLE statute in a manner similar to its interpretation of the investment direction provisions in Section 529, ABLE account beneficiaries will be able to redirect existing account balances among the ABLE program’s investment options twice per year, and will be able to direct the investment of any new contributions at the time the applicable contribution is made. Again, because the ABLE beneficiary may be a minor or have a disability that precludes investment decisions, a person with power of attorney to make such investment decisions on the beneficiary’s behalf may be required.

h. Effect on Eligibility for Means-Tested Programs

Aside from availability of funds for savings purposes, a frequent impediment to saving for a dedicated purpose such as higher education expenses or disability expenses is the perception that such savings may reduce the amount of available funding from other sources, such as financial aid in the case of college savings accounts and federal or state disability assistance in the case of disability savings accounts. The ABLE legislation addresses this issue by generally excluding ABLE account balances and distributions from being counted for purposes of means-tested federal programs.

There are two exceptions relating to the Supplemental Security Income (SSI) program: distributions from an ABLE account for housing expenses are not excluded, and the excess of an ABLE account balance over $100,000 is counted and may result in the suspension of SSI benefits during any period in which such excess amount remains in the ABLE account. Even if SSI benefits are suspended due to an ABLE account balance in excess of $100,000, the beneficiary’s Medicaid eligibility is not impacted by such suspension.

i. State Reimbursement Claim upon Beneficiary’s Death

Upon the death of an ABLE account beneficiary, a state that has paid for the beneficiary’s medical costs incurred after the account was established may claim reimbursement from any balance in the ABLE account for such payments, net of any premiums paid on the beneficiary’s behalf to a Medicaid Buy-In program. The 10% income tax surcharge is inapplicable to any such distribution to a state.

j. ABLE Program Verification and Reporting Requirements

Under Section 529A, a state establishing an ABLE program is not required to verify the eligibility of a beneficiary for whom an ABLE account is opened; that appears to be between the beneficiary and the IRS, subject to any regulations that may be promulgated by the Treasury Secretary. Similarly, as is the case with Section 529 programs, an ABLE program is not required to determine whether distributions are qualified for tax-exemption or taxable. However, an ABLE program must report to the Treasury Secretary, at the time an ABLE account is established, the name and state of residence of the beneficiary, and must report on a monthly basis to the Commissioner of Social Security distributions from and account balances for each ABLE account.

Section 529A permits the Treasury Secretary to adopt regulations “providing for the information to be presented to open an ABLE account”, among other topics. The Treasury Secretary may also require the state sponsor of an ABLE program to report to the Treasury Secretary and account beneficiaries “with respect to contributions, distributions, the return of excess contributions, and such other matters as the Secretary may require.”

II. Getting ABLE Programs Off the Ground

a. State ABLE Legislation

The enactment of Section 529A will authorize the establishment of ABLE programs effective January 1, 2015, but ABLE accounts will not be available to families anxious to take advantage of tax-exempt savings for disabled beneficiaries until the beneficiary’s state of residence launches an ABLE program or enters into a contract with another state permitting its residents to use an ABLE program launched by the other state. A state is likely to require legislation authorizing a particular state agency or instrumentality to establish and administer an ABLE program, and it is also likely that legislative authorization would be required for a state to contract with another state for resident access to the other state’s ABLE program. Some states have already passed ABLE legislation in anticipation of the enactment of the federal tax benefit, but many states still need to do so before their residents can access the new tax benefit.

States that have not yet enacted ABLE legislation will need to determine whether the authority to launch and operate the state’s ABLE program should be granted to the state agency or instrumentality responsible for the state’s 529 college savings program, or to a different entity. Given the similarities between Section 529A and Section 529, there appear to be obvious efficiencies in consolidated administration of such programs. On the other hand, disability advocates may prefer administration of ABLE programs by state officials or boards with expertise in disability matters, even though the duties of ABLE program administrators are primarily investment-oriented.  Some states may elect to provide their Section 529 and Section 529A programs under the same roof, but include individuals with disability expertise on the applicable board or advisory council.

b. Program Managers and Investment Options

The consensus around the desirability of ABLE programs suggests the existence of substantial pent-up demand for investing in such programs. However, the current $14,000 per year contribution limit, and an ABLE program’s inability, with the limited exception of the “contracting state” provision, to attract out of state residents, are likely to result in a much longer ramp-up period for ABLE programs than for the more successful 529 programs, and smaller amounts of assets under management. States establishing ABLE programs will need to evaluate the pros and cons of lumping their 529 and 529A programs together for purposes of program management contracts and other potential administrative cost efficiencies inherent in combining the two asset pools operationally, while segregating them for legal and tax purposes.

Similarly, states establishing ABLE programs and their investment managers will need to consider the efficiency of offering similar investment options and underlying investments in their ABLE programs and college savings programs. One obvious adjustment that will need to be made is in age-based options, the most popular options under 529 programs, in which investments follow an increasingly conservative investment glide path as the account beneficiary approaches presumed college age. Age-based options may also be useful in ABLE programs, but considerable financial tinkering will be required to make them appropriate for expenditures over a disabled beneficiary’s lifetime versus the much narrower higher education window. The fact that many ABLE accounts are likely to be fiduciary or custodial accounts rather than accounts in which the account owner owes no fiduciary duty to the account beneficiary may also influence the investment line-up offered by ABLE programs.

 

 

 

By LEN WEISER-VARON

After initially putting the brakes on the MSRB’s attempt to use underwriters of Section 529 college savings plans as its data-gathering team, the SEC has pressed the accelerator and approved an amended MSRB Rule G-45  requiring such underwriters to submit periodic electronic reports to the MSRB providing specified data regarding the applicable Section 529 plan.

The final rule requires semi-annual reporting on new Form G-45 regarding the plan’s assets, asset allocations for each plan investment option, plan contributions, plan withdrawals, plan fees and costs and certain other information, and annual reporting on such form of performance data for each plan investment option.  The “accelerated” rule will become effective on February 24, 2015, with the first semi-annual report due by August 30, 2015.

Much of the data to be submitted under Rule G-45 is already available in the periodically updated offering documents from Section 529 plans, on the issuer’s or program manager’s websites and/or on the College Savings Plan Network’s website, albeit not for consistent periods across Section 529 plans as Rule G-45 requires.  Other required data, such as aggregate contribution and withdrawal levels, is not generally available from plan disclosure.

By approving the new rule, the SEC has endorsed the MSRB’s use of its jurisdiction over brokers of municipal securities to obtain information about municipal fund securities that it lacks statutory authority to obtain directly from the municipal issuers of such securities, just as the SEC, in promulgating SEC Rule 15c2-12, leveraged its authority over brokers to  prompt enhanced initial and continuing disclosure by municipal bond issuers.

Unlike information required under SEC Rule 15c2-12, the Section 529 plan data to be submitted by underwriters to the MSRB will not be disclosed to Section 529 plan investors, at least initially, but rather used by the MSRB to monitor Section 529 plans and evaluate the need for and type of further regulation affecting that niche of municipal securities.  The MSRB has telegraphed, however, that at a future date it may engage in further rulemaking to share its trove of Section 529 plan-related information with investors.  And having established the precedent of requiring Section 529 plan underwriters to serve as data conduits for plans they distribute, the MSRB may also over time expand the categories of such data from those specified in the freshly minted Rule G-45, as the SEC has done with its Rule 15c2-12.

The procedural history of the MSRB’s new rule is peculiar.  The proposed rule was filed by the MSRB with the SEC on June 10, 2013.  Following a comment period, on September 26, 2013 the SEC took the unusual step of instituting proceedings to determine whether it should disapprove the proposed rule, suggesting, among other reasons, that substantial questions had been raised about the cost-benefit aspects of the proposed regulation.  The MSRB then filed a response to the comments submitted on the proposed rule, as well as an amended version of the proposed rule with some clarifications.  On February 21, 2014, the SEC approved the amended rule on an accelerated basis, stating that the MSRB’s response and rule clarifications had satisfied the SEC on the concerns raised by commenters.  The SEC invited further comment on the amended rule, even though the rule is now approved.  The MSRB, in a February 24, 2014 notice, stated that the rule would become effective on February 24, 2015.   The SEC’s initial lack of support for the MSRB’s proposal, and its subsequent accelerated approval of the slightly revised proposal, has generated a modicum of regulatory whiplash among followers of the rule’s progress.

In addition to jurisdictional and cost-benefit objections, comments on the proposed rule focused on its definition of “underwriter” and on an underwriter’s access to the data the rule requires underwriters to submit.  Most Section 529 plans involve retention by the governmental issuer/plan sponsor of a broker-dealer to distribute the plan securities, with other non-broker-dealer entities providing investment advice, recordkeeping and administrative services.  The entities providing the non-distribution services may or may not be affiliated with the broker-dealer and may provide such services pursuant to a contract with the plan sponsor or pursuant to a subcontract with the broker-dealer.   The MSRB’s rulemaking notice included language suggesting that the plan sponsor and other entities that are not registered broker-dealers might, under certain circumstances, be deemed “underwriters” subject to the Rule.  Commenters protested that the MSRB can only regulate broker-dealers.

The MSRB’s letter accompanying its amended version of Rule G-45 retracted the suggestion that the governmental issue/plan sponsor might be an “underwriter” but, as to other entities involved in Section 529 plan program management, doubled down on the proposition that, depending on the facts and circumstances, entities that are not registered brokers might, in performing services as a Section 529 plan contractor or subcontractor, perform functions that are “broker” functions and therefore “underwriter” functions.   The SEC approved the MSRB’s slightly revised position on “underwriter” status.

Commenters also raised concerns about Rule G-45’s apparent assumption that a Section 529 plan’s underwriter has access to and the right to provide to the MSRB plan data that may be maintained on behalf of the plans by affiliated or unaffiliated entities with which the underwriter may or may not have contractual privity.  (Unlike SEC Rule 15c2-12, which requires underwriters to enter into contracts with governmental issuers under which issuers agrees to provide the specified disclosure items, Rule G-45 directly requires Section  529 plan underwriters to provide the specified data to the MSRB.)   The MSRB and SEC have indicated that Rule G-45 requires an underwriter “to submit only information it possesses or has a legal right to obtain.”  The SEC’s rule approval noted that “the MSRB [has] stated its belief that an underwriter has a legal right to obtain all information that is related to its activities in connection with the underwriting, even when it has designated an affiliate or contractor to perform such activities.”

As to concerns that confidentiality or other constraints on the underwriter’s obtaining or sharing of plan-related information should be taken into account, the SEC endorsed the MSRB’s statement that “the legal right to obtain information for purposes of Rule G-45 is not affected by a ‘voluntary relinquishment, by contract or otherwise, of such a right.’’”

To the extent the MSRB continues to use its authority over broker-dealers as a point of access to Section 529 plan data it seeks or wants disclosed to investors, further skirmishing over  the MSRB’s view of information that a Section 529 plan underwriter “has a legal right to obtain” may lie ahead.

By LEN WEISER-VARON

The IRS recently issued a private letter ruling, PLR 201310043 (released on March 8, 2013), of interest to Section 529 plans and their program managers. The ruling relates to the tax treatment of incentive contributions to 529 accounts and was issued in response to a ruling request by a financial services complex described as including a bank and broker. The firm requested guidance on tax reporting of incentive payments credited by the firm to 529 accounts established through the firm. The firm credited the incentive payments directly to the owner’s account when a 529 account owner funded a specified minimum to the account within 30 days of opening the account and maintained that balance for a minimum of 90 days.

The ruling concluded that such incentive payments are properly characterized as a payment by the financial services firm to its client, followed by a contribution by the client to its 529 account. This recharacterization of the transaction from one to two steps avoided the potential applicability of Section 529(c)(2) of the Code, which treats “any contribution to a qualified tuition program on behalf of a designated beneficiary … as a completed gift to such beneficiary…”, and the ruling emphasized that the payment constituted “non-gift funding.” Accordingly, the IRS ruled that the payment was income received by account owner and that, if such income exceeded $600 in one year, the firm was required to report the payment to the IRS and the recipient.

The ruling declined to characterize the incentive payment as non-reportable income on a 529 account, stating that the payment “is paid by you of your own accord as a bank and brokerage, and not by or on behalf of [the] State as an establisher and maintainer of a [qualified tuition program.]” Accordingly, the ruling does not address state matching or incentive programs in which money is contributed to an account by the 529 program sponsor rather than by its program manager or another third party entity. The ruling also does not address contributions of credit card “rewards” to 529 accounts; such “rewards” typically are treated as discounts on the purchase price of the charged item, rather than as income.