Section 127 of the IRS Code allows employers to establish a program to provide tax-free payments of up to $5,250 per year to eligible employees for qualified educational expenses. Historically, the law defined qualified educational expenses as expenses incurred by an employee including: tuition, fees and similar payments, books, supplies, and equipment.
- Tuition for undergraduate or graduate programs. (Note that these expenses do not need to be job-related.)
- Books, supplies, and necessary equipment. (Note that meals, lodging, transportation, or supplies that employees may keep after the course is completed are not eligible.)
The maximum tax-free benefit is $5,250 per year per employee.
CARES Act Expands to Include Student Loan Payments
The CARES Act amended Section 127 to include student loan repayment assistance as a qualified educational expense. This expansion allows employers to make payments for student loans on a tax-free basis.
Tax benefits for employees include federal, state, and FICA taxes. Tax benefits for employers include tax deductibility of benefit payments made as well as the employer portion of FICA taxes.
Expansion is Temporary
Originally, the CARES Act expanded Section 127 to include student loan payments only between March 27, 2020, and December 31, 2020. However, the Consolidated Appropriations Act (signed on December 27, 2020) further extended the provision for five years through December 31, 2025.
Educational Assistance Plan Requirements
In order to take advantage of this benefit, employers must set up a formal plan, and it must meet specific requirements, as follows:
- Employer must have a written educational assistance plan.
- Plan may not offer a choice between taxable benefits or other remuneration (cash or noncash) and a benefit under the educational assistance program.
- Plan may not discriminate in favor of highly compensated employees.
- Plan may not provide more than 5% of total benefits paid to owners or shareholders owning more than 5% of the stock.
- Employees may not receive more than $5,250 (from all employers combined).
- Employees must be provided with reasonable notification of the availability and terms of the plan.
Mechanism of Student Loan Payments
Payments for student loans (including principal and interest) may be made directly to employees as reimbursement for amounts already paid or may be made directly to the lender. Note that documentation of student loan payments made is a requirement for both employee reimbursements and direct payments to lenders.
The IRS is actively promoting awareness of this benefit and is taking steps to highlight it for employers. There will be a free 75-minute webinar on Thursday, September 14, 2023. It will begin at 2 p.m. ET and will include a question-and-answer session. To register for the webinar or for more information, visit the Webinars for Small Businesses page on IRS.gov.