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IRS to propose 529 anti-abuse rules

(January 18, 2008) - The IRS has issued an advance notice of proposed rulemaking, meaning a new set of proposed regulations under section 529 is forthcoming. Comments submitted by March 18, 2008 will be considered by the IRS in its development of the proposed regulations.

The new regulations will contain several anti-abuse provisions as required by the 2006 Pension Protection Act. In addition, there will be a number of clarifications and modifications to the current set of proposed regulations (issued in 1998).

In its release, the IRS briefly describes the rule changes it expects to make with the proposed regulations, including the following:

- a general anti-abuse rule by which the IRS may recharacterize the tax treatment of contributions or transfers deemed abusive, based on subsequent events.
- a change in the "deemed gift" rules when the beneficiary is changed to a lower-generation beneficiary: the gift will be from the account owner and not from the former beneficiary.
- possible requiring that the account owner be an individual..
- treating a nonqualified distribution to the account owner as taxable income except to the extent the account owner can substantiate his or her own contributions to the account.
- a change in beneficiary to a same-generation or higher-generation beneficiary will be treated for gift-tax purposes as a new contribution by the account owner.
- rules clarifying whether the account balance is includable in the estate of the beneficiary after the beneficiary's death.
- permitting 529 distributions to be applied to qualified expenses paid through March 31 of the following year.

Further analysis of the IRS release may reveal other issues. On an overall basis, the proposals coming from the IRS seem reasonable, even modest, but there is still a lot of work to be done in coming up with the proposed regulations.

For more information, click here.

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