Under Internal Revenue Code section 127, an employee maygenerally exclude from income amounts received pursuant to anemployer-sponsored tuition assistance or educational assistanceprogram (EAP) that was established in order to fund employeeeducation-related expenses, subject to the maximum limitationdiscussed below.

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This exclusion was made permanent by EGTRRA 2001 following anumber of extensions in preceding years.

Amounts received under an EAP may be excluded whether or not theeducational expenses are job related.

An employee cannot exclude from income more than $5,250 ineducational assistance benefits in any calendar year.

“Educational assistance,” for purposes of an employer-sponsorededucational assistance program (EAP), is generally defined in IRCSection 127 as an employer’s payment of expenses incurred by anemployee for education. Expenses such as tuition, fees, books,supplies, equipment and employer-provided courses of instructionincluding books, supplies and equipment are all included withinthis definition.

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Educational assistance does not include payments for tools orsupplies that the employee may keep after finishing the course ofinstruction, as well as meals, lodging and transportation. Paymentfor any course or education involving sports, games or hobbies isnot 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 oris receiving credit toward a more advanced degree, if theparticular course can be taken for credit by any individual in aprogram leading to a law, business, medical, or other advancedacademic or professional degree.”

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According to IRS guidance, a course will be considered to beginon the first regular day of class for the courses offered duringthat term. The date upon which a student registers for a course hasno effect on the date the course is considered to have started forpurposes of the Section 127 exclusion.

The following requirements must be met by an employer-sponsorededucational assistance program (EAP) to receive tax-preferredtreatment:

• Written plan: the program must be a separatewritten plan of the employer providing educational assistance forthe exclusive benefit of the company’s employees. A sole proprietormay treat himself as employer and employee and a partnership willbe treated as the employer of all self-employed partners.

• Nondiscrimination: the program must benefitemployees who qualify under a classification set up by the employerthat does not discriminate in favor of highly compensatedemployees, as defined in IRC Section 414(q). Generally, highlycompensated employees are 5 percent owners or members of thetop-paid group of employees. Employees covered by a collectivebargaining agreement may be excluded if educational assistancebenefits were the subject of good faith bargaining.

• More than 5 percent owners: the class ofshareholders and their spouses and dependents, each of whom ownsmore than 5 percent of the employer’s stock, cannot receive morethan 5 percent of the educational benefit amounts.

• Employee choice: a program cannot offeremployees a choice between educational assistance and otherbenefits that are includable in income.

• Funding: an educational assistance program maybe funded or unfunded.

• Notification: eligible employees must receivereasonable notification of the program’s availability andbenefits.

A plan will still be considered in compliance with theserequirements even though different types of educational assistanceare used more than others or because successful completion of thecourse or obtaining a certain grade is required or considered inthe process of obtaining reimbursement under the plan.

Further, a plan will continue to meet the requirements ofSection 127(b) even if it provides benefits to former employees.Included in the category of former employees are retirees, personswho were unable to work due to disability, persons whose positionswere terminated due to a corporate downsizing, persons who left theemployer voluntarily and employees who were involuntarilyterminated from their positions.

Until 2002, an employer who maintains an Educational AssistanceProgram under IRC Section 127 was required to file an informationreturn (Schedule F to the Form 5500) for each year that the programis in effect.

The information return had to include the number of employeescurrently working, the number of employees eligible to participatein the plan, the number of employees actually participating, thetotal plan cost, and the number of highly compensated employees. Inaddition, the employer was required to identify itself and statethe type of business in which it is engaged.

Notice 2002-24, however, suspended these reporting requirementswith respect to EAPs and certain other employee fringe benefits.Employers are relieved of the obligation to file under Section3039D until the IRS provides further notice.

Notice 2002-24 superseded Notice 90-24, which exempted plansunder Section 127 from furnishing the additional informationconcerning highly compensated employees that was required by theTRA ’86 amendments to Section 6039D.

This reporting relief applies to any plan year that begins priorto the issuance of further guidance on this subject by the IRS.