Attract and retain employees through educational assistance programs

This article was originally published on April 11, 2023, and has been updated.

Employer-provided education assistance, including student loan payments, is increasingly popular in today’s environment of high education costs, tight workforce competition, and specialized job duties. The opportunity to participate in educational programs may not only improve recruitment and retention, but also help employers maintain an educated and skilled workforce.

Fortunately, tax rules provide employers with two avenues to pay for employee education without creating taxable income for employees (whether it is paid directly or reimbursed to the employee). However, the tax rules relating to the establishment and maintenance of tax-free education can be hard to navigate. This brief explanation highlights the two main tax-free alternatives:

1. Section 127 educational assistance programs which limit tax-free reimbursements (including student loan payments) to $5,250 per employee annually, and
2. Working condition fringe benefits which do not have an IRS dollar limit on reimbursements.

Section 127 educational assistance programs

Employers may provide tax-free educational assistance, including student loan payments, through an educational assistance program that qualifies under section 127 by meeting the following requirements:

• The employer maintains a separate written plan. The IRS has released a sample plan document. However, employers should review this plan document with their legal counsel before using it.
• The plan provides only educational assistance with no option to receive other taxable compensation or benefits under the program.
• The plan is only for employees and does not extend to their family members.
• The plan does not discriminate in favor of officers, shareholders, or highly compensated employees (the plan can be limited to specified classes of employees, so long as the classifications are nondiscriminatory).
• The employer gives employees reasonable notice of the terms and availability of the program.
• The plan does not cover education expenses for sports, games or hobbies unless they are related to the employer’s business or part of a degree program.

If the program meets all these criteria, an employer may exclude up to $5,250 in educational assistance benefits per employee each calendar year from taxable income. The employer can either provide the educational assistance by paying qualifying expenses directly or by reimbursing employees for their qualifying expenses. Any unused amount of this limit cannot be carried forward to future years.

Some employers may also require employees receiving educational assistance to follow certain other company-imposed policies before reimbursement, such as minimum grade requirements, retention guidelines or documentation procedures, but these are employer-imposed restrictions and are not part of the tax requirements. An employer may choose to incorporate these stipulations into their written plan document.

Educational assistance programs can cover expenses incurred for tuition and fees, books, supplies, and equipment but cannot include meals, lodging, transportation, or tools and supplies (other than textbooks) that employees can keep after the course is over. The courses taken do not need to be related to the employee's current job responsibilities or be part of a degree program.

For additional information, see the IRS Frequently Asked Questions (FAQs) on section 127 educational assistance programs.

Student loan payments

Because the level of student loan debt held by Americans continues to grow, Congress expanded educational assistance programs to permit tax-free payments of certain student loans through December 31, 2025. The IRS FAQs address student debt and qualified education loans. Employers can either pay the student loan servicing company directly on behalf of the employee or reimburse the employee upon substantiation of the expense. The $5,250 annual cap per employee applies to student loan debt and other educational expenses combined. If an employer already has an educational assistance program and would like to expand it to include student loan payments, it should amend its plan to incorporate this additional benefit.

Working condition fringe benefits

Employers may be able to provide tax-free education to their employees as a working condition fringe benefit regardless of whether they have a section 127 educational assistance program. Education expenses that don’t qualify under section 127 or that exceed the $5,250 limitation may also be reimbursable under the working condition fringe benefit rule.

The tax laws for working condition fringe benefits are quite involved and generally require a case-by-case analysis. In general, employer-paid education expenses are excluded from an employee’s taxable income if the expenses are directly related to the employee’s current job responsibilities. Expenses will typically meet this criteria if the education:

• maintains or improves skills required by the employer, or
• meets the express requirements of the employer, or the requirements of applicable law or regulations, imposed as a condition of the employee’s continued employment, status, or rate of compensation.

Additionally, for the educational expenses to be tax-free to employees as working condition fringe benefits, the education must not:

• assist employees in meeting the minimum entry-level educational requirements for their current positions, nor
• qualify the employees for a new field of employment.

Although this second requirement may seem straight-forward, a long line of case history reflects a broad interpretation of education that qualifies employees for a new field of employment. Therefore, a very careful analysis of each employee’s situation often needs to be done for education that extends beyond internal, on-the-job training.

For more information on educational expenses as working condition fringe benefits, see IRS Publication 15-B (Employer’s Tax Guide to Fringe Benefits).

Summary

The following chart reflects the primary differences between the two methods employers can use to reimburse employees for education expenses.

As employers look for ways to offer additional employee benefits or provide training to employees, education often becomes part of the compensation package. Employers may choose to structure education benefits in various ways to meet their goals and provide meaningful benefits to employees. Due to the tax rules involved, educational benefits require careful consideration to avoid unintended tax consequences so employers should seek guidance from their tax advisors.