Employer-Provided Educational Assistance
The federal government offers many deductions and tax credits to help Americans finance education. One of the best of these is the employer-provided educational assistance. An employer can provide up to $5250 of educational assistance benefits each year to an employee that is not includable as compensation to the employee. The educational assistance is one of the few fringe benefits not subject to income taxes, payroll taxes or federal unemployment taxes. The educational assistance plan must be written and meet certain other requirements, under IRC §127. However, none of the expenses paid by the employer can be used as a basis for any other deduction or credit such as the American opportunity credit or the lifetime learning credit.
To qualify for tax-free treatment, the educational assistance program must be a separately written plan provided only to employees that also satisfies all the following rules:
- The plan does not favor highly compensated employees, which are any employees who owned at least 5% of the employer's business at any time either during the current or the preceding year or if the employee was paid more than $115,000 in the preceding year, unless the educational assistance program was part of a collective bargaining agreement and that the educational assistance was bargained in good faith.
- More than 5% of the benefits of the program does not go to shareholders or owners who, at any time during the year, owned more than 5% of the stock, or the capital or profits interest of the employer's business.
- The employees cannot be offered any other benefit instead of the educational assistance that would be includable in income.
- Reasonable notice of the program must be given to all eligible employees.
To qualify for the tax-free treatment, the educational assistance must be used for payments for tuition, fees, books, supplies, and equipment. Equipment and supplies only qualify, however, if they are used only during the course. If it is something that the student can keep afterwards, then those expenses, except for textbooks, do not qualify.
Other expenses that do not qualify include meals, lodging, or transportation and courses on sports, games, or hobbies unless they are either required as part of a degree program or they are reasonably related to the employer's business.
Qualified expenses do not require that the courses taken be work related nor, unlike many other educational tax benefits, do the courses have to be part of a degree program. The educational assistance can also be used to finance graduate courses.
Any amounts paid over $5250 are taxable to the employee, so the employer should include that portion of the assistance as wages on Form W-2, Wage and Tax Statement. However, payments greater than $5250 may be excludable from the employee's income if it is a working condition fringe benefit, which is a benefit that would be deductible as an employee business expense if the employee had paid it.
An employee is defined, for the purposes of the educational assistance benefit, as any of the following individuals:
- a current employee
- an employee who has left because of retirement, disability, or was laid off
- a leased employee who has worked full-time for at least a year under the employer's direction or control
- a sole proprietor
- a partner employed by the partnership.
Educational Benefits for Employees' Children
An employer can set up a private foundation that can provide educational grants to the children of the employees that will be treated as nontaxable scholarships or fellowships if the program is nondiscriminatory and if the primary purpose of the grant program is to provide an education, evinced by the following rules:
- grant decisions must be based only on standards unrelated to the employer's business or to the employment of the parent, such as aptitude tests, academic performance, financial needs, and recommendations from instructors
- grant recipients must be selected by a scholarship committee who is independent of both the employer and the foundation, which does not include former employees of either
- grant eligibility may depend on a minimum number of years of employment with the employer, but they may not depend on the parent employee's position, services, or duties
- once the grant is awarded, it may not be contingent on the continued employment of the parent, and if the grant is renewable, renewability may not be affected by the parent's termination of employment
- all courses must be available to the grant recipients, regardless of whether they benefit the employer or the foundation
- the grant program cannot be used as a means of recruiting employees nor as motivation for employees to continue their employment, and neither the child nor the parent is expected to provide future employment services in exchange for the grants
If the above conditions are satisfied and the main purpose of the grant program is clearly to provide an education for the employees' children, and not as additional compensation to employees, then the grants will be considered as nontaxable scholarships or fellowships. There is also an additional percentage test that will ensure that the IRS will not treat the grant program as additional compensation if the number of grants awarded per year to children of employees is either:
- no more than 25% of the children who were eligible, applied for the grants, and were reviewed by the committee; or
- no more than 10% of the children were eligible, regardless of whether they applied for the grant
Any educational program that is offered only to the children of key employees or is based on continued employment rather than on the children's needs or merits will be taxable as additional compensation to the employees.
Employers May Offer Employees Repayment Assistance for their Student Loans
Instead of offering tuition paid benefits, an employer may offer employees repayment assistance on their student loans. In response to the Covid-19 pandemic, Congress recently passed 2 laws, Coronavirus Aid, Relief, and Economic Security (CARES) Act and the Consolidated Appropriations Act for 2021 (H.R. 133), signed into law on December 27, 2020, allowing employers to contribute up to $5250 annually toward an employee’s student loan until 2025, and such assistance will be free of federal and employment taxes. The CARES Act also pauses monthly payments on privately held student loans until September 30, with no interest charges. Few companies offer student loan repayment assistance, but this may increase with the new laws.
The loan assistance must pay down the employee’s debt, not that of a spouse or child. Any amounts paid by this loan assistance cannot be deducted under the provision for the student loan interest deduction. (No double dipping!)
To offer this assistance, the employer should amend an existing written educational assistance program (EAP) or create a separate written policy satisfying the requirements of §127, Educational Assistance Programs, including not favoring highly compensated employees and employees must be notified of this assistance. The EAP also cannot allow employees to choose between educational assistance and other compensation includable in gross income.