Under Internal Revenue Code section 127, an employee may generally exclude from income amounts received pursuant to an employer-sponsored tuition assistance or educational assistance program (EAP) that was established in order to fund employee education-related expenses, subject to the maximum limitation discussed below.
This exclusion was made permanent by EGTRRA 2001 following a number of extensions in preceding years.
Amounts received under an EAP may be excluded whether or not the educational expenses are job related.
An employee cannot exclude from income more than $5,250 in educational assistance benefits in any calendar year.
“Educational assistance,” for purposes of an employer-sponsored educational assistance program (EAP), is generally defined in IRC Section 127 as an employer’s payment of expenses incurred by an employee for education. Expenses such as tuition, fees, books, supplies, equipment and employer-provided courses of instruction including books, supplies and equipment are all included within this definition.
Educational assistance does not include payments for tools or supplies that the employee may keep after finishing the course of instruction, as well as meals, lodging and transportation. Payment for any course or education involving sports, games or hobbies is not considered to be “educational assistance.”
The IRS, in Notice 96-68, has defined a graduate level course as “… any course taken by an employee who has a bachelor’s degree or is receiving credit toward a more advanced degree, if the particular course can be taken for credit by any individual in a program leading to a law, business, medical, or other advanced academic or professional degree.”
According to IRS guidance, a course will be considered to begin on the first regular day of class for the courses offered during that term. The date upon which a student registers for a course has no effect on the date the course is considered to have started for purposes of the Section 127 exclusion.
The following requirements must be met by an employer-sponsored educational assistance program (EAP) to receive tax-preferred treatment:
Written plan: the program must be a separate written plan of the employer providing educational assistance for the exclusive benefit of the company’s employees. A sole proprietor may treat himself as employer and employee and a partnership will be treated as the employer of all self-employed partners.
Nondiscrimination: the program must benefit employees who qualify under a classification set up by the employer that does not discriminate in favor of highly compensated employees, as defined in IRC Section 414(q). Generally, highly compensated employees are 5 percent owners or members of the top-paid group of employees. Employees covered by a collective bargaining agreement may be excluded if educational assistance benefits were the subject of good faith bargaining.
More than 5 percent owners: the class of shareholders and their spouses and dependents, each of whom owns more than 5 percent of the employer’s stock, cannot receive more than 5 percent of the educational benefit amounts.
Employee choice: a program cannot offer employees a choice between educational assistance and other benefits that are includable in income.
Funding: an educational assistance program may be funded or unfunded.
Notification: eligible employees must receive reasonable notification of the program’s availability and benefits.
A plan will still be considered in compliance with these requirements even though different types of educational assistance are used more than others or because successful completion of the course or obtaining a certain grade is required or considered in the process of obtaining reimbursement under the plan.
Further, a plan will continue to meet the requirements of Section 127(b) even if it provides benefits to former employees. Included in the category of former employees are retirees, persons who were unable to work due to disability, persons whose positions were terminated due to a corporate downsizing, persons who left the employer voluntarily and employees who were involuntarily terminated from their positions.
Until 2002, an employer who maintains an Educational Assistance Program under IRC Section 127 was required to file an information return (Schedule F to the Form 5500) for each year that the program is in effect.
The information return had to include the number of employees currently working, the number of employees eligible to participate in the plan, the number of employees actually participating, the total plan cost, and the number of highly compensated employees. In addition, the employer was required to identify itself and state the type of business in which it is engaged.
Notice 2002-24, however, suspended these reporting requirements with respect to EAPs and certain other employee fringe benefits. Employers are relieved of the obligation to file under Section 3039D until the IRS provides further notice.
Notice 2002-24 superseded Notice 90-24, which exempted plans under Section 127 from furnishing the additional information concerning highly compensated employees that was required by the TRA ’86 amendments to Section 6039D.
This reporting relief applies to any plan year that begins prior to the issuance of further guidance on this subject by the IRS.