IRS Issues New FAQs on Educational Assistance Programs

With the new academic year approaching, the IRS recently issued timely guidance on employer-sponsored educational assistance programs under Section 127. The “frequently asked questions” (FAQs) fact sheet provides information on the tax treatment and benefits available to employees and employers.

As an invaluable recruiting and retention tool, these programs offer significant tax advantages by allowing employees to exclude certain education-related benefits from their taxable income, while also providing employers with a tax deduction for these payments.

Employee Benefits

Under Section 127, employees can exclude up to $5,250 in qualified educational assistance benefits from their gross income per calendar year. These benefits are considered separate from regular income and should not be included in regular wages on Form W-2.

In addition, amounts received for an educational assistance program by an employer cannot be further utilized as a basis for any additional deduction or credit, including the lifetime learning credit. Such expenses cannot be claimed or co-mingled with other tax breaks.

Qualifying and Non-Qualifying Expenses Under Section 127

The following types of education-related expenses qualify for exclusions from an employee’s income:

• Tuition
• Fees
• Books
• Supplies
• Equipment

To further assist employees with educational costs, the CARES Act introduced a temporary provision allowing employers to exclude from gross income payments made on qualified education loans between March 27, 2020, and January 1, 2026. These payments are included in the $5,250 annual exclusion limit per employee and are not allowed for education loans for the employee’s spouse or dependents.

Below are expenses that do not qualify under Section 127, including:

• Meals, lodging, and transportation
• Tools or supplies (other than textbooks) retained by the employee
• Courses involving sports, games, or hobbies, unless required as part of a degree program or having a reasonable relationship to the employer’s business
• Education for dependents

Owners and shareholders of the employer may receive educational assistance benefits, however, not more than 5% of the total benefits paid by the employer during the year may be paid to the owners or shareholders, including their spouses and dependents.

While Section 127 excludes certain education-related expenses, consider alternative tax provisions that may allow deductions for other education costs.

Employer Benefits

Not only do employees benefit from educational assistance programs, but the amounts paid under Section 127 are generally deductible by the employer as a business expense under Section 162. Additionally, employers are not required to report these amounts as employee wages or pay FICA or FUTA payroll taxes for benefits provided under the program.

To qualify for these tax advantages, the IRS requires employers to create a written plan for the educational assistance benefits that adheres to the following criteria:

• Must offer solely educational assistance.
• Spousal and dependent benefits do not qualify.
• Must benefit all employees equitably.
• Cash alternatives and other forms of compensation are prohibited.
• Benefits must be specifically defined for qualifying educational expenses.

Employers that meet these requirements may exclude up to $5,250 in annual educational assistance benefits per employee from taxable income.

While not mandated by law, some employers may also impose additional stipulations, such as minimum grade point averages or job retention periods, as part of their program guidelines to safeguard the integrity of the program and protect the investment.

Although some educational assistance programs can be costly, investing in employee education and development can cultivate a more skilled, engaged, and loyal workforce overall.

Further Consideration

To learn more about the rules and tax implications under Section 127, read the complete IRS FAQs on educational assistance programs. Should you have any additional questions pertaining to your situation, please contact me at (520) 881-4900 to discuss.