United States

Attract and retain employees through educational assistance programs

Appropriate planning can create a tax-free win-win scenario

INSIGHT ARTICLE  | 

Employer-provided education 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 allow employers two avenues to pay for employee educationwithout 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 tax-free alternatives.

Exclusion up to $5,250

One way employers may provide tax-free educational assistance is to offer an education assistance program that qualifies under section 127. To qualify for this specific exclusion, the following requirements must be satisfied:

  • The employer maintains a separate written plan
  • The plan provides only educational assistance with no option to receive other taxable compensation or benefits under this program
  • The plan is only for employees (not 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 of these criteria, an employer may exclude up to $5,250 in educational assistance benefits per employee each year from taxable income. Some employers may also require employees receiving educational assistance to follow certain other company imposed policies before reimbursement, such as minimal grade requirements, retention guidelines, or documentation procedures, but these are employer-imposed restrictions, they are not part of the tax requirements to qualify. The section 127 benefit can include 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 exclusion provides a great benefit to employees as it applies whether or not the courses taken are related to the employee's current job responsibilities or are part of a degree program.

Working condition fringe benefit

If an education benefit does not qualify under section 127 or exceeds the $5,250 limitation above, the employer may be able to provide tax-free education to its employees as a working condition fringe benefit. The tax laws for working condition fringe benefits are quite involved and generally require a case-by-case analysis, but generally, this rule can allow an employee an exclusion from gross income for employer paid or reimbursed education expenses that would be considered deductible business expenses if incurred directly by the employee because it is directly related to an employee's current job responsibilities. The expenses will generally meet these 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 the current position, nor
  • qualify the employees for a new field of employment.

While at first blush, this second requirement seems straight-forward, a long line of case history shows a more broad interpretation of qualifying for a new field of employment than one might think. Therefore, a very careful analysis of each situation often needs to be done for education that extends beyond internal, on-the-job training.

To briefly summarize the major differences in the two exclusions:

 

Education limitation

Dollar limitation

Education assistance program

Generally only excludes sports and hobbies

$5,250/employee/year

Working condition fringe

Work-related

None

 

As employers look for ways to offer additional employee benefits or to provide necessary training to employees, education often becomes part of the compensation package. Employers may choose to structure education benefits in various different ways to meet their goals and provide a meaningful benefit to employees. Due to the tax rules involved, educational benefits require careful consideration to not have unintended tax consequences. Employers should seek guidance from their tax advisors as appropriate at every stage of the process.


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