Two Ways to Reconcile Education Assistance Benefits with the Tax Code
Employees are leaving their jobs at an alarming rate. Some experts call it the Great Resignation. Since we can’t think of anything smarter, we’ll stick with it. Unfortunately for businesses, hiring is both exhausting and expensive. In fact, it is much cheaper to retain employees than to find new ones.
In such a seller’s market, how do you retain and motivate your employees? One option to consider is to increase your benefits to provide education assistance benefits. This can be an attractive perk for new hires and existing employees. Training assistance will also benefit employees who have been on long-term leave and need to upgrade their skills.
If you’re considering differentiating your business in this way, the tax code gives you two ways to approach it: an easy way and a hard way.
The easy way
IRC § 127 allows you to provide up to $5,250 per year to employees in tax-free education assistance benefits, with few conditions.
Your educational assistance program must be a separate written plan and meet the following requirements:
- It benefits employees who are eligible under the rules you have established.
- Your rules cannot favor highly paid employees.
- The program does not provide more than 5% of its benefits to shareholders or owners, or their spouses or dependents.
- Employees cannot elect to receive cash or other taxable benefits in lieu of education assistance. In other words, you cannot offer this program as part of your cafeteria plan.
- You give eligible employees reasonable notice of the program.
- Employees justify their expenses to you.
Your plan can be as wide or as narrow as you want. Employees can use their § 127 benefits for personal purposes, such as pursuing an undergraduate or graduate degree unrelated to their current job, or they can take business courses that will enable them to meet the minimum requirements necessary for promotion.
Limit #1: You generally cannot pay or reimburse employees for classes that qualify as sports, games, or hobbies.
Limit #2: If you are already recovering a portion of student loan expenses from employees, you must subtract the amount you are recovering from the current employee education assistance entitlement.
If you don’t want to be bothered with monetary caps, IRC § 162 allows you to recoup or reimburse 100% of employee employment-related training costs. This type of education allows employees to maintain or improve their current skills, without qualifying them for new jobs. This also includes education required by law or by you.
Why is this the hard way? Because the trick is to make the education expenses qualify for tax-exempt treatment in the first place. As going to school is inherently personal, the IRS interprets this section of the tax code very closely. For example, you can never afford expenses associated with undergraduate degrees; higher education expenses fare a little better.
Example. David performs sales, marketing and management functions for Sparky. He continues to do so while in graduate school for his MBA and after graduating. Sparky can exclude these expenses from David’s income because earning an MBA is not a prerequisite for his current job. Although the MBA improves his business, marketing, and sales skills, it does not qualify him to perform very different tasks and activities than he could perform before the MBA.
Moreover, the logic of the IRS is circular. So you can pay for courses employees need to maintain or improve their current skills, but you can’t exclude those expenses from employees’ income if the education allows them to meet the minimum requirements of their current job or qualifies them for new jobs, even if, at the same time, the training maintains or improves the skills that employees currently need.
Could vs Intent: To determine whether a course qualifies an employee for a new job or business, look at what they could do with their newly acquired knowledge, rather than what they intend to do. If the training enables an employee to perform very different tasks and activities than they could perform before, the training qualifies them for a new trade or business.
At the end of the line : Because eligibility for tax-exempt treatment under IRC § 162 is risky, employment-related educational assistance expenditures should be limited to seminars or refresher courses .