The Internal Revenue Service (IRS) recently released updated Frequently Asked Questions (FAQs) about educational assistance programs under Section 127 of the Internal Revenue Code (“Code”). Section 127 allows employees to receive certain educational benefits from their employer on a tax free basis. Employers who offer, or are considering offering, a Section 127 educational assistance program should review the updates covered below carefully.
What is a Section 127 Educational Assistance Program?
A Section 127 educational assistance program is a written plan that allows an employer to provide certain tax-free educational assistance benefits to its employees. The IRS provides a sample written plan document that employers can use as a starting point for drafting their specific educational assistance plan which may have different eligibility and benefit amounts, subject to the non-discrimination requirements discussed below.
Who can participate in a Section 127 Educational Assistance Program?
A Section 127 educational assistance program is exclusively for employees and may not be used to reimburse the educational expenses of their spouses or dependents. While benefits can be provided to all employees, a Section 127 educational assistance program cannot discriminate in terms of eligibility in favor of officers, shareholders, self-employed, or highly compensated.
Shareholders and officers can receive educational assistance benefits, but not more than 5% of the amounts paid or incurred by the employer for educational assistance can be provided to a class of individuals who are shareholders or owners who own 5% or more of the stock or of the capital/profits of the employer. This limit includes any spouses and dependents of shareholders and owners who are also employees of the employer.
What Benefits can be Provided under a Section 127 Educational Assistance Program?
Tax-free educational assistance benefits under Section 127 educational assistance program include:
- Tuition, fees, and similar expenses;
- Books, supplies, and equipment; and
- Principal or interest payments on qualified education loans (as defined in Section 221(d)(1) of the Code)
Employers are not required to reimburse all possible expenses and can limit the types of educational benefits they want to reimburse.
Importantly, educational assistance benefits do not include:
- Meals, lodging or transportation;
- Tools or supplies (other than textbooks) that you can keep after completing the course of instruction (ex: laptop that is kept following completion of education); and
- Courses involving sports, games or hobbies unless they:
- Have a reasonable relationship to the employer’s business, or
- Are required as part of a degree program.
Employers can provide up to $5,250 per calendar year in educational assistance benefits on a tax-free basis. Unused amounts do not carry forward to subsequent years. This is amount is indexed for inflation for tax years beginning after 2026.
What is a Qualified Education Loan?
A qualified educational loan is a loan for education at an eligible educational institution including any college, university, vocational school or other postsecondary educational institution. A qualified educational loan can be incurred by the employee prior to beginning employment and employers can make payments in subsequent years.
Student debt incurred by an employee that can be categorized as a Section 127 expense could be reimbursed by an employer provided the employee can substantiate the expenses to the employer. For example, if a qualified education loan was used to pay for both tuition and lodging, the portion used to pay tuition could be reimbursed tax-free while the portion used to pay for lodging could not.
Employers are permitted to directly pay qualified education loans to a third party such as a loan provider or make payments directly to an employee.
Other Tax-Free Benefits
- Working Condition Fringe Benefit: Educational benefits that qualify as a working condition fringe benefit are excluded from gross income regardless of amount. See Working Condition Benefits in section 2 of Publication 15-B, Employer’s Tax Guide to Fringe Benefits for more information.
- Educator Expense Deduction: Eligible K–12 educators may be able to deduct up to $300 ($600 if married filing jointly with both spouses qualifying) for unreimbursed business expenses.
Employees would be well served to discuss with a tax advisor if either of these exclusions apply to their tax situation.
Key Takeaway
Employers who offer a Section 127 educational assistance program, or are considering it, would be well served to review the updated FAQs put out by the IRS. Employers already offering a Section 127 educational assistance program should ensure their plan is up to date and accurate. Those who are interested in offering a Section 127 educational assistance program for the first time should review the necessary requirements and can use the sample plan document as starting point.
The information provided is a summary of laws and regulations relating to employee benefit plan compliance. This information should not be construed as legal advice. In all cases, employers should consult with their own legal counsel.
