The Tax Cut and Jobs Act became law at the very end of 2017, and affects taxes for the current year. Many commentators have dissected how the tax cut law will affect tax rates, and business taxes. That’s not all the Act contains, however. A number of changes will particularly affect our older clients or individuals with disabilities. They — and their family members — should know about some of those changes.
ABLE Act changes
In the past two years we have written often about the development of ABLE Act accounts. These investment accounts are modeled after Section 529 education accounts, but with key differences. They do permit people with disabilities to save modest amounts of money.
Arizona has not yet adopted an ABLE Act account arrangement, though we are very close (expect a public announcement within about a month). In the meantime, there is no reason not to look into opening an account in another state’s program. We particularly like the Ohio “Stable Account” and Nebraska’s “Enable Account” variations.
Meanwhile, the two big changes included in the tax cut law, both effective for 2018:
- People with ABLE Act accounts sometimes also have earnings (from part-time or sheltered workshop jobs, for instance). Now the $15,000 limit on annual ABLE contributions has been raised for them, at least in some circumstances. Assuming they do not participate in an employer-sponsored retirement plan, they can put some or all of their income into their ABLE Act account. Other family members can still make their contributions to the account, too.
- Did you (or another family member) set up a 529 education account for your child? Perhaps there is an old 529 account from before anyone realized that the beneficiary might have a disability. The tax cut law permits at least a limited roll-over from that 529 account into an ABLE Act account.
Both of these new developments come with limitations. For some people who qualify, taking advantage of the flexibility won’t actually make sense. Talk to your attorney about the effect and options before implementing the changes. But the new laws do give you (or your family member with a disability) new options.
The “Kiddie” tax
This change might be an illustration of the law of unintended consequences. Apparently the law’s authors were trying to simplify things. They might have accidentally increased tax liabilities for some children with special needs trusts.
A minor child who has a special needs trust (perhaps from settlement of a personal injury lawsuit) has to file a federal income tax return. Of course, the trustee — or the parents — usually takes care of the filing itself. The minor’s tax return has to include his or her parents’ tax returns. The child then pays income taxes at his or her own tax rate or that of the parents — whichever is greater.
The new tax cut law eliminates the need to get parents’ tax returns (and, sometimes, those of other siblings). But it does that by setting the child’s effective tax rate at the highest marginal rate for trusts. That means that the effective tax rate will almost always be at the highest possible rate, regardless of parents’ actual income.
For most minors with money, the change will probably not be a very big deal. If they have money, it typically comes from gifts from wealthy parents — and the highest tax rates are already in effect. But if the parents have modest income, and the child has significant wealth and income, the answer will be different, and the taxes much higher. That will affect many — perhaps most — children with sizable special needs trusts.
Qualified Disability Trusts
Speaking of special needs trusts, there is also some good news. Third-party special needs trusts — the kind set up by a grandparent, or even a parent, to handle an inheritance or a gift — have long had a special tax benefit. The beneficiary will usually be able to claim a personal exemption, and the special needs trust gets to claim another personal exemption.
That means that about $8,000 of trust income usually avoids income taxation altogether. But the new tax cut law changes the calculation — partly by eliminating the personal exemption altogether.
Hold on, though — here’s the good news: the tax law leaves an equivalent deduction in place for the special needs trust. That means that the first $4,150 of trust income still avoids taxation. The beneficiary’s personal exemption is gone, but he or she will get the benefit of the increased standard deduction. The net effect should be a reduction in the total income tax — at least for trusts that make significant distributions for the beneficiary.
Retirement account planning
There’s another change that might be of particular interest to seniors. Actually, it is not really a change at all — the option is still the same as it was before the tax cut law. But we think more people will utilize it now.
Suppose you are age 75, and you have to take annual minimum distributions from your IRA (or other qualified retirement account). In fact, this year you will have to take out $10,000. That will show up on your tax return as ordinary income.
You also have been making $5,000/year contributions to your favorite charity. You might even want to increase that amount. But in the past you have not gotten the full value of your charitable contributions. Why not? Because you only get to deduct a portion of your charitable gifts. Worse yet, the portion you get to deduct is affected by the $10,000 of IRA income.
The problem is compounded by the new tax cut law. Because more taxpayers will benefit from the standard deduction, you might not get any income tax benefit from your generous charitable gift. Enter the “qualified charitable contribution” notion.
How does it work? It’s simple. You just direct $5,000 of your minimum required distribution directly to the charity. You never get the check (talk to your IRA custodian about how to do this). That $5,000 payment is not included in the income you report on your tax return. You get the full value of the charitable gift.
The new tax cut act will make qualified charitable contributions much more attractive. Talk to your elder law attorney or CPA about how it might work for you.
The tax cut law includes other, less-discussed, provisions that affect seniors and those with disabilities. We think these are the most important ones to know about.