How are ABLE Account Distributions to Heirs Taxed?
ABLE account taxation
Question:
Must a sibling or nephew heir of an of the remaining balance in an ABLE account have to pay taxes on the funds received? The ABLE custodian does report the distribution to the IRS on Form 1099-QA.
Response:
That’s an interesting question, and I believe that the answer is “yes” to the extent the distributed funds are investment earnings rather than the initial funds deposited into the account.
By way of background, ABLE accounts are safe harbors that allow individuals who were disabled before age 26 (slated to be changed to age 46 in 2026) to shelter up to $100,000 without these funds being considered in determining eligibility for Medicaid, Supplemental Security Income (SSI) or other public benefits programs. Similar to 529 accounts created to fund college expenses, the investment earnings on ABLE funds are not taxable and distributions on behalf of beneficiaries are not taxable as long as they are used for qualified disability expenses, basically just about anything on behalf of the beneficiary.
ABLE accounts require that upon the death of the beneficiary, the state Medicaid agency be reimbursed for its expenses on the beneficiary’s behalf. In most cases, this completely depletes any remaining funds in the account. But if there’s some money left over, it can be paid to named beneficiaries. I believe that these payments are taxable to the extent of investment earnings since the distribution to the heirs does not qualify as a disability expense eligible for the income tax exception.
In this way, ABLE accounts are more like Roth IRAs than traditional IRAs. Since Roth IRAs are funded with after-tax funds, only the earnings are taxed when the funds are withdrawn. All withdrawals from traditional IRAs are taxed since they are funded from income that has never been taxed.
All in all, these payments will result in very little tax paid by very few people. Most ABLE account funds go to the state Medicaid agency. Any amounts passing to heirs are likely to be small and the investment earnings on such amounts even smaller.
Related Articles
Don’t know how your trust works?
Whether you’re creating a plan, managing a trust, or are a beneficiary of a trust, this book is your easy-to-read roadmap.
