First, the news: Arizona has now legislated a state income tax deduction for ABLE Act contributions, beginning this year. Now, let us explain what that means.
Let’s start with the ABLE Act itself
As a reminder, Congress passed the Achieving a Better Life Experience (ABLE) Act at the end of 2014. It allowed states to create special accounts for people with disabilities. The ABLE Act was modeled on — but is quite different from — education accounts commonly referred to as Section 529 accounts.
Though the law was in effect by early 2015, the first ABLE Act accounts weren’t actually available until mid-2016, when Ohio, Tennessee and Nebraska started their accounts within a few weeks of one another. In early 2018, Arizona signed on to the Ohio plan. Arizona residents can sign up with other states’ plans, but the Arizona 529 plan is based on that Ohio program.
To participate, a potential ABLE Act beneficiary must have become disabled by age 26. The beneficiary can deposit their own funds, or others can deposit money for them. And the beneficiary can use the funds for all sorts of things — including rent, food, entertainment, travel, education and other expenditures.
But until now, contributions to an ABLE Act account have been post-tax. That is, the contributor could not deduct their deposits on either their federal or their Arizona state income tax returns. That has now changed.
ABLE Act contributions are deductible — but with limits
Beginning with the 2021 tax year (that is, the return you file in April, 2022), you can deduct ABLE Act contributions of up to $2,000 on your Arizona income tax return. That can mean that the beneficiaries contributions are deductible (though that is usually not very helpful). So are contributions from family members or others.
Married couples can deduct up to $4,000. And that deduction is per ABLE Act account. So a couple who contribute $4,000 each to three different ABLE Act accounts can deduct $12,000 from their Arizona income taxes.
There is no requirement that the contributions be to the Arizona ABLE Act account, either. If you contribute to the account run by a different state, it is fully deductible. There also is no requirement that the beneficiary be a relative.
The new rules were adopted by the Arizona legislature on June 30, the last day of its 2021 session. The law specifically applies to contributions made in any tax year starting after December 31, 2020.
Note: ABLE Act contributions are NOT deductible on the donor’s federal income tax return.
So should everyone contribute to ABLE Act accounts now?
Well, hold on. There are still negatives, and the new tax deductibility doesn’t resolve all of them.
First, remember that ABLE Act accounts revert to the State on the death of the beneficiary — at least to the extent that Medicaid (AHCCCS) benefits have been paid. There are some exceptions, but that’s the basic rule. So trading a small income tax deduction for an ultimate loss of the principal might not be all that attractive.
Since the contribution amount is limited, and federal income tax benefits are not available, the value of the new tax benefit is also small. Arizona’s income tax rate tops out at 4.5%, so the maximum tax savings on a $4,000 contribution (for a married couple) is $180. And if the contributor doesn’t pay any state income tax, they also get no benefit from the deduction.
It is true that earnings inside an ABLE Act account avoid both state and federal income tax. So a long-term investment might pay the beneficiary much more than the $180 benefit available to the donor. But the longer the money stays in the account, the more likely it becomes that it ultimately reverts to the State.
As we’ve already mentioned, the ABLE Act beneficiary also gets an Arizona state income tax deduction for his or her contribution. For someone with a modest state income tax liability, that might mean a little more than $100 in state income tax savings. Nothing to complain about, but hardly a game-changer.
Who will benefit most from the new tax benefit?
Imagine a young ABLE Act beneficiary — Peter — who lives in the community. He receives Supplemental Security Income (SSI) payments of $510/month, because his parents pay his $1000/month rent directly. SSI reduces his payment by $285/month based on that rent payment.
Peter’s parents are relatively well-off, but not wealthy enough to simply buy a house or condo for Peter. They live and work in Arizona.
Peter’s parents could set up an ABLE Act account for him, and contribute the same $1,000 per month to cover Peter’s rent. Since the ABLE Act contributions are not treated as income for SSI purposes, that would increase his SSI to the maximum available (currently $794/month). And now, Peter’s parents get a $180/year income tax break from the State of Arizona. Everyone comes out a little bit ahead. Even the government benefits, since Peter’s care is less expensive thanks to his parents’ contributions.
Is that the only way to benefit?
Peter and his parents are the clearest beneficiaries of the new law. But there’s also Sharon, who gets monthly Social Security Disability (SSD) based on her father’s account. When he turned 70 several years ago, her 50% benefit exceeded the SSI payment she had been receiving. Now she’s on Medicare, and getting no benefits from AHCCCS (Medicaid).
Sharon’s parents also contribute money to her ABLE Act account — but not to cover her rent. She lives with them and has no immediate needs. Her parents think of the contributions as a tax-advantaged savings account for their daughter, who will not have to worry about the payback provision in the ABLE Act, since she is unlikely to ever receive Medicaid benefits. So now Sharon’s parents also get a small — $180/year — state income tax benefit for their contributions.
The ABLE Act created a number of opportunities for disabled beneficiaries. The new favorable income tax benefits expand those opportunities — if only slightly. Interested Arizona residents might want to talk with their special needs planning attorney about how their facts fit into the new structure.
