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Tax Bill’s Effect on Educational Assistance

Tuition Assistance Addressed in Last Month’s Tax Bill

In passing the tax bill last month, Congress voted to extend several Bush-era tax cuts, including one for employer-provided educational assistance. The following post tells how the tax code differentiates between educational assistance that is directly related to the job and assistance that is not job-related.

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Last month, Congress was able to pass H.R. 4853, the Tax Relief Unemployment Insurance Reauthorization and Job Creation Act of 2010, and President Obama signed it into law. Among other things, the Act ensures that that individual’s tax brackets and capital gains and dividend tax rates remain at the same levels as 2010, for at least two more years. It also cuts payroll taxes for employees for one year, lowering the Social Security tax on income up to $106,800 from 6.2% to 4.2%.

In addition, you should be aware of another tax provision that was extended that could affect your bottom line. Specifically, the provision that allows employees to exclude from their income up to $5,250 a year in educational assistance that is not directly job-related has been extended for another two years.

(Download a free Educational Assistance model policy including HR best practices and legal background.)

This provision, often referred to as Section 127 after its tax code citation, 26 U.S.C. §127, applies to both undergraduate and graduate work that is not directly related to the employee’s job. Job-related educational assistance is also tax deductible as an employer business expense. Below is a discussion of the points you need to know about these educational reimbursement provisions.

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Editor's Note regarding citations used in this article: References to "U.S.C." and "C.F.R." refer to the United States Code and Code of Federal Regulations. They both are official government publications for federal statutes and regulations, respectively. Cites to "Rev. Rul." refer to rulings by the Internal Revenue Service.

 

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Section 127 Extended

Section 127 of the tax code allows employees to exclude from their income up to $5,250 a year in educational assistance that is not directly job-related. (See 26 U.S.C. §127.) This provision applies to both undergraduate and graduate work. In order for the exclusion to apply, you must have a separate, written plan for education assistance that does not discriminate in favor of highly compensated employees. In addition, you must not exceed specific limits on assistance to owners, their spouses, or dependents.

Section 127 was originally passed in 1978 as a temporary tax measure. Since then, it has expired and been extended repeatedly, creating administrative problems in the years when it was retroactively reinstated. In some years, the exclusion applied only to undergraduate course work and excluded graduate level courses. However, the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) amended Section 127 to extend the exclusion for employer-provided educational assistance to graduate courses and make "permanent" the exclusion as applied to both undergraduate and graduate education.

However, the EGTRRA contained an automatic sunset, or expiration, provision of December 31, 2010. So, the exclusion was due to expire altogether next week unless Congress intervened. After several weeks of rancorous debate and high level discussions between the White House and Senate Republicans, Congress finally passed a package to extend the EGTRRA cuts, including extending Section 127 until December 31, 2012. The Act also extended unemployment benefits for up to a total of 99 weeks.

Expenses Directly Related to the Job

Remember, too, that employer assistance with education expenses that are directly related to the employee's job generally qualifies as a working condition fringe benefit that is not treated as taxable income to the employee. (See 26 U.S.C. §132(d).) Furthermore, you may deduct amounts paid to employees for this assistance as a business expense.

To qualify for this job-related deduction, the education program must:

(1) Maintain or improve skills required for the current job;

(2) Not be required to meet minimal educational requirements for the current job; and

(3) Not qualify the employee for a new trade or profession. (See Rev. Rul. 76-71, 1976-1 C.B. 308. See also 26 U.S.C. §162(a); 26 C.F.R. §1.162-5.)

(Download a free Educational Assistance model policy including HR best practices and legal background.)

For federal income tax purposes, employees do not have to report amounts received as reimbursement for the above educational expenses, as long as the reimbursement does not exceed the actual expenses and the employee is required to, and does, account for the expenses to his employer. (See 26 U.S.C. §1.162-17(b).)

Of course, because of the complexities of the tax code, it is prudent to seek the advice of a tax expert when implementing these deductions.

Regards,

Robin Thomas, J.D.
Personnel Policy Service, Inc.

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