The right and wrong way to provide employee education assistance

You can help employees with their current educational expenses, pick up their student loans, or even help out employees’ children with their educational expenses. But if you don’t do things correctly, the benefits you provide will be taxable to employees, which defeats your goal.

Learn from this employer’s mistake.

529 plans aren’t for employers

IRC § 529 allows states and educational institutions to establish qualified tuition programs. These programs allow donors—parents, mostly—to contribute on an after-tax basis to accounts to pay for their children’s qualified education expenses.

Tax advantages: Distributions from QTPs are tax-free to children, unless the amount distributed is greater than their qualified education expenses. Once one child graduates, parents can roll over the money for their younger child’s education.

According to the IRS, however, the key to tax-free distributions under a § 529 plan is that the donor can be anyone, except an employer.

The IRS wasn’t specific about how this employer’s § 529 plan was structured when it concluded its contributions were taxable fringe benefits to employees. But we can understand its reasoning, if the plan was structured like most employer-based § 529 plans—employers match employees’ contributions. Since there’s nothing in the tax code excluding these matching contributions from income, they’re taxable.

Better options

IRC § 127 allows you to underwrite an employee’s educational expenses, up to $5,250 a year. Your plan must be written, it can’t favor highly compensated employees, and employees must substantiate their expenses to you.

You could limit the courses the company is willing to pick up to job-related courses or even require employees to pay back their benefits if they terminate within a certain number of years, although the Consumer Financial Protection Bureau looks askance at repayment agreements.

IRC § 127 also allows you to pick up part of employees’ student loans, but the $5,250 total applies.

You can skip the $5,250 cap and pay 100% of employees’ educational expenses, if you limit the courses employees take to job-related courses and their education doesn’t qualify them for a new trade or profession. In reality, however, this is extremely difficult to do, since the IRS takes an expansive view of a “new trade or profession.” You couldn’t, for example, underwrite employees’ bachelor’s or law degrees. You can sometimes underwrite employees’ MBA degrees, but the catch is their job duties after receiving their MBA must be the same as the job duties they performed before.

Employees often take out loans for their children’s education. You can help out here, too, if you set up a private foundation authorized to award scholarships to employees’ children. You’ll need some professional advice to set up the foundation as a 501(3) tax-exempt organization and to set the objective criteria for employees’ children to qualify for scholarships, but it may be worth it, since you can use this perk as a recruiting tool.

Free webinar

The IRS is hosting a free webinar on employer-provided educational assistance on Sept. 14 at 2:00 p.m. Eastern. Point your browser here to sign up.

Steer employees to new repayment plans

Employees may be feeling financial pressure, if they’re one of the millions of borrowers who must begin repaying their student loans in a scant month or so.

The Department of Education has a new income-driven repayment plan, called the SAVE Plan. Employees can sign up for it here. Under the SAVE Plan, interest no longer accrues & borrowers earning $15 an hour pay back $0.