Benefits you provide to your employees must be included in their gross income – they have to pay tax on it – unless it’s specifically excluded from income by the Internal Revenue Code. A benefit which is excluded from income can be worth a lot more to your employees.
Exclusion for educational assistance benefits
Gross income of an employee doesn’t include amounts paid or expenses incurred under a qualified educational assistance program. Each employee can exclude up to $5,250 per calendar year.
What taxes are involved
If the benefits qualify, they are excluded from federal income taxes and social security and Medicare taxes. Be sure to check into your state’s tax treatment of educational assistance benefits.
What kind of assistance qualifies
The definition of education for this purpose is broad – it means any form of instruction
or training that improves or develops an individual’s capabilities. It does not need to be related to the employee’s current job. The education can be part of a degree program, but it doesn’t have to be. The education can be provided directly by the employer, or through a third party such as a college or other educational institution. Graduate level courses also qualify (there was a time when they didn’t).
The costs can be paid directly to an educational institution by the employer, or the employee can make the payment and then receive reimbursement from the employer. Employees must be able to substantiate the educational expenses.
The following kinds of costs qualify for the exclusion:
- Tuition
- Fees
- Books
- Supplies
- Equipment
However, these don’t qualify:
- Education involving sports, games, or hobbies, unless it involves the business of the employer or is required as part of a degree program
- Tool or supplies (other than textbooks) that the student may retain after the course of instruction ends
- Meals
- Lodging
- Transportation
More on the dollar limitation
The maximum amount of educational assistance that an employee can receive tax-free during any calendar year is $5,250. The excess over this amount is subject to income and social security taxes. If an individual receives educational assistance from more than one employee, the total amount that can be excluded is still $5,250.
Note that the employee is not allowed to manipulate the annual $5,250 limit by electing to postpone receipt of reimbursements to another tax year. If the reimbursement was offered by the employer, the employee is in constructive receipt of the reimbursement in that tax year.
Qualified program
The educational assistance program must meet the following requirements to be a qualified program:
- It must be a separate written plan of the employer. The terms must be set forth in a separate document that covers only educational assistance that qualifies for the exclusion.
- The plan can’t offer a choice between educational assistance and cash wages or other taxable compensation
- The program must be exclusively for the employees of the employer. For this purpose, the plan may include (but is not required to include) retired, disabled, or laid-off employees. The plan may not benefit employees’ spouses or dependents.
- Employees who are eligible to participate must be given reasonable notice of the availability and terms of the program
- The program does not need to cover all employees, but it must benefit one or more classes of employees that does not discriminate in favor of highly compensated employees. A highly compensated employee for this purpose is one that received more than $115,000 in pay in the preceding year, and was in the top 20% of employees as ranked by pay for the preceding year. Note that a plan won’t be disqualified just because it is used to a greater degree by highly compensated employees.
- The program cannot discriminate in favor of 5% owners – see below
Benefits for 5% owners
The educational assistance program doesn’t qualify for exclusion from income for any program year in which more than 5% of benefits were provided for owners who each owned more than 5% of the stock or capital or profits interest of the employer.
- Employees who are also spouses or dependents of 5% owners also count as 5% owners for this purpose
- Attribution rules apply to the 5% ownership test. An owner is deemed to own for this purpose the interest of certain family members or ownership from certain other relationships.
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