Employer Paid Tax-Free Educational Assistance Now Includes Up to $5,250 in Student Loan Repayment
Under Section 2206 of the CARES Act enacted in March of 2020, tax-free educational assistance to employees now also includes loan payments made by employers to or on behalf of employees for their eligible student loan debt. The Consolidated Appropriations Act, 2021 (CAA), signed into law by President Donald Trump on Dec. 27, 2020, extends the favorable tax provision until 12/31/2025.
Educational Assistance Program ("EAP") under Section 127 of the Internal Revenue Code has long provided the opportunity for employers to help employees with their current education expenses on a tax-free basis. After the CARES Act revision, employers can now help employees pay down student loans for prior educational expenses as well. Qualified payments include payments made by employer to an employee or directly to a lender consisting of principal and/or interest on any qualified education loan incurred by an employee for his or her education.
It is important to remember that only payments offered through a compliant and nondiscriminatory Sec. 127 EAP can be excluded from employee income. For employers with an established EAP, adding the student loan repayment option should be easy. Employers without an existing program will have to implement a qualified EAP before offering the student loan repayment benefit to employees.
-- Written plan. A separate written plan is required but it doesn't have to be lengthy or complex.
-- Solely educational assistance. EAP can only provide benefits that meet the definition of "educational assistance". Note that employees may not have a choice between receiving educational assistance and a taxable benefit, including cash compensation (such as a bonus). In other words, the educational assistance must be provided in addition to their other compensation or benefits, not in lieu of. Also, employers cannot offer the educational assistance under Sec. 125 "cafeteria plan".
-- Only For Employees. Sec. 127 program is available only for current, retired, disabled, laid-off employees, or employees on leave. Tax-free benefits cannot be offered to employees' spouses or dependents.
-- Nondiscrimination. EAP must benefit employees generally and cannot discriminated in favor of officers, shareholders, self-employed, or highly compensated employees. However, eligibility for benefits can be limited to a certain classification of employees (such as certain departments, functions, new hires, etc.) as long as that classification doesn't discriminate in favor of owners or highly compensated employees.
-- Limitations on Owners. Benefits to owners are limited and cannot exceed 5% of total educational assistance paid for the year
-- Notice Requirement. All eligible employees must be given a reasonable notice of the availability and terms of the program.
-- Substantiation. Employers must obtain and retain documentation related to eligible expenses paid under the program.
-- Annual Limit. Only up to $5,250 can be excluded from income each year. Any amount paid to or on behalf of employees in excess of this amount must be included in the employees' taxable income.
The recent expansion of the available benefits under the educational assistance program is a welcome change and employers should consider whether it makes sense to establish the EAP for their business.