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Several thousand companies offer tuition assistance programs as a fringe benefit for employees who want to further their college studies. The tax treatment of these Employer Educational Assistance Programs (IRS Section127) can be tax-deductible to the employer and also tax-free, up to $5,250 per year, to the employee. The Tax Relief Act of 2001 extended this benefit to students enrolled in graduate-level studies.

Employers are not required to offer educational assistance to employees. However, with increased technology in the workplace, the continuing education of employees is necessary to ensure the employer will stay competitive in the marketplace. Many employers recognize this and choose to offer educational assistance benefits.

Education Assitance Plan Qualifications

Particular IRS regulations must be followed to qualify for this benefit. To be qualified, an Educational Assistance Plan must meet the following requirements [IRC Sec. 127(b)]:

• Must be a separate written plan of the employer. The terms of the plan (i.e., eligibility, benefit requirements, and claims procedures) must be outlined in a separate document specifying the details of the tuition assistance that qualifies for the exclusion.
• Must be used for the exclusive benefit of employees. The term “employee” may include retired, disabled or laid-off employees, employees on leave (e.g., in the U.S. Armed Forces), and self-employed persons. However, the program can not benefit employees’ spouses or dependents, unless they are also employees of the employer.
• Must be nondiscriminatory. The plan must meet an eligibility test and a 5% concentration test.
• Reasonable notice of the availability and terms of the educational assistance program has to be provided to all eligible employees.

The self-employed business owner can also set up an Educational Assistance Plan. The advantages of these programs can be substantial for both the self-employed business person and the employee. They are as follows:

• The employee does not have to report the amount (up to $5,250 per year) of the educational assistance as income on his tax return.
• The employer and the employee are not responsible for any payroll taxes (up to $5,250 per year) on this type of employee compensation.
• The employer receives a current tax deduction for the education assistance paid.
• The employer does not have to fund this program, as is the case in other types of employee benefits.

The self-employed business owner can also provide this fringe benefit for their children if they employ them in their business. The courses the children take need not be job-related. To qualify for this fringe benefit, the following tests must be met:

1. The child must be a legitimate employee of the business,
2. The child must be age 21, or older, unless the business owner is a grandparent funding a grandchild’s education, in which case there is no age limit,
3. The child must not own more than 5% of the business and, the child must not be a tax dependent of the parent/business owner.

Benefits of An Education Assistance Plan

Under Section 127 of the Internal Revenue Code [IRC Sec. 127(a)(1)] any amount paid, or expense incurred, by employers for educational assistance for their employees can be deducted by the business owner and also excluded from the employee’s gross income (up to $5,250 per year).

If self-employed business owners employ their children and meet the stipulations under IRS Section 127, they may be able to deduct one or two years of undergraduate college costs when the child turns age 21, or up to $5,250 to $10,500. If the child decides to attend graduate school, the benefits are even more significant. In this case, the money paid for tuition assistance for the employee/child can be deductible to the self-employed business owner, yet will not be treated as income to the employee/child.

Tax Savings

The primary tax benefit of Education Assistance Plan strategy comes from the ability to deduct one or two years of undergraduate college costs when the child turns age 21, or up to $5,250 to $10,500. If the child decides to attend graduate school, the business owner can further deduct the graduate school tuition and expenses for the employee/child. This strategy is another excellent way also to reduce your family’s total tax liability.

Case Example

Tom is a self-employed business owner whose son will be a 21-year-old junior in college this year. Since Tom’s son is employed in his business during the summer months, Tom can deduct tuition and fees incurred during the next two years of school. If Tom’s son needs a fifth year to graduate, he can deduct tuition and fees for that year also. If his son decides to attend graduate school, Tom can deduct the graduate school tuition and fees too (up to $5,250 per year).

In 2017, Tom will pay 25% in federal taxes, 6% in state taxes and 15.3% in self-employment taxes, for a total tax rate of 46.3%. Assuming Tom’s son will graduate in two years (and incurs at least $5,250 in tuition costs each year), Tom can now deduct $5,250 each year for those two years, which will result in a tax savings of $2,431 each year ($5,250 x 46.3% = $2,431).

Implementing An Education Assistance Plan

• Step 1: Prepare a corporate resolution – If you have a corporation, a partnership, or a Limited Liability Company (LLC) you should have an attorney draw up a resolution to incorporate the Education Assistance Plan (Section 127) as an employee benefit into your business.
• Step 2: Establish an Employer Identification Number (EIN) – If you operate as a sole proprietor (you file IRS form Schedule C or F), you should apply for an Employer Identification Number (EIN). You can apply for the Employer Identification Number (EIN) online or by using IRS SS-4 Form.
• Step 3: Determine the eligible employees (children/grandchildren).
• Step 4: Execute an employment agreement with the children/grandchildren (employee) – When hiring your child you need a formal hiring process that should include the completion of a standard Employment Application, W-4 form, and an I-9 form.
• Step 5: Determine the plan's education benefits (Example: only pay for a limit on tuition of 10,000, or for undergraduate studies only, not graduate studies).
• Step 6: Reimburse the employee/child or the education providers directly for the cost of the tuition and fees. Be sure to use a company check.
• Step 7: Deduct the cost of the education assistance plan benefits as “Employee Benefits” on your IRS tax return.

Documents Needed to Implement

These are the documents you will need to implement the Education Assistance Program:

• Employer identification number (IRS SS-4 Form)
• Employment Application, W-4 form, and an I-9 form
• Educational Assistance Plan Document
• Employee Tuition Expense Reimbursement Form

IRS Publications

• Employer's Tax Guide to Fringe Benefits
  Publication 15-B – Education Assistance Plan
• Publication 970 (2017), Tax Benefits for Education

Forms

• SS-4
• W-2
• W-4
• I-9
• 941

Examples

Educational Assistance Plan

Employment Agreement (Child)

Employee Education Expense Reimbursement Sheet