Tax-free student loan payments
Expansion of section 127 plans through 2025
INSIGHT ARTICLE |
Authored by RSM US LLP
Given that the level of student loan debt held by Americans continues to grow at a rapid pace, employer-paid education assistance continues to be a hot topic among college graduates hoping to snag their first job out of college and experienced hires alike. Conversations around what level of assistance the government should provide to these individuals have been gaining steam for a couple years and likely will continue. In the meantime, COVID-related legislation in 2020 and 2021 did expand education assistance programs under section 127 to permit tax-free payments of certain student loan payments through December 31, 2025.
Here are answers to some frequently asked questions about section 127 educational assistance program benefits.
Q: What type of education assistance is available under section 127 and how has this changed recently?
A: Under this type of program, an employer can provide up to $5,250 per year of tax-free education benefits to each employee. Until this past year, these programs only covered current educational expenses, and thus, could not cover student loan payments. However, under the CARES Act, section 127 was temporarily expanded to include payments of principal and interest on any qualified education loan incurred by the employee for their own benefit, through December 31, 2020. The Consolidated Appropriations Act subsequently extended this provision through December 31, 2025. If you already have a section 127 plan, you may be interested in amending that plan to cover these now eligible student loan payments, or alternatively, you may be interested in adopting a new plan to take advantage of this provision.
It’s worth noting, section 127 plans are not the only way an employer can provide education benefits to employees. If an education benefit does not qualify under section 127 or exceeds the $5,250 annual limitation, the employer may be able to provide tax-free reimbursement as a working condition fringe (although student loan debt would not meet these requirements). For further details on what constitutes a working condition fringe benefit, see this article on how to attract and retain employees through educational assistance programs.
Q: What are the requirements of a section 127 plan?
A: To qualify for this specific exclusion, the following requirements must be satisfied:
- The employer maintains a separate written plan.
- The plan provides only educational assistance with no option to receive other taxable compensation or benefits under the program.
- The plan is only for employees and does not extend to their family members.
- The plan does not discriminate in favor of officers, shareholders, or highly compensated employees.
- The employer gives employees reasonable notice of the terms and availability of the program.
- The plan does not cover education expenses for sports, games or hobbies unless they are related to the employer’s business or are a requirement of the degree program.
Q: If I implement a section 127 plan, am I required to make it available to all employees?
A: No, while the plan cannot discriminate in favor of officers, shareholders, or highly compensated employees, you can tailor the plan to provide benefits only to the class or classes of employees the employer desires so long as the classification is not discriminatory. In addition, you may choose to limit the types of expenses that your plan will cover (e.g. only student loan payments and no other education payments).
Q: Can I include other stipulations in the section 127 plan document?
A: Yes, employees receiving educational assistance can be required to meet certain other company polices, as defined in the section 127 plan document you adopt. For instance, you may want a policy related to minimal grade requirements, employee service length requirements, and repayment policies in the event these stipulations are not met.
Q: If we pay part of an employee’s student loan and the employee quits, can we require the employee to repay us?
A: Yes, you may include a repayment policy in the section 127 plan document you adopt, detailing how long the repayment clause is in effect after an employee participates in this program. It is particularly important that the employee agrees to this repayment requirement in writing and that you consider what state law requirements or restrictions may apply on repayments.
Q: What type of document substantiation is required?
A: For current education benefits, tuition statements or other receipts detailing expenses will typically meet the requirements of substantiation. When evaluating substantiation from employees, you should ensure the following questions can be answered; what amount was paid or incurred, the school or company the amount was paid to, and the date such amount was paid or incurred. Be mindful that amounts reimbursed cannot include amounts paid for meals, lodging, transportation, or tools and supplies (beyond textbooks).
For student loans, the same information is necessary which may be found in a student loan statement or payment history detail. In addition, only student loans incurred by the employee for their benefit are eligible for tax-free treatment so it’s prudent for the employer to document that this requirement has been satisfied. We’d recommend the employer request this representation by the employee in writing so they have adequate documentation for their files.
Q: Can a company pay the student loan servicing company directly?
A: Yes, the company can either reimburse the employee or pay the student loan servicing company directly.
Q: If these payments are tax-free to employees, is the employer entitled to a deduction for tax purposes?
A: Yes, the employer is entitled to a deduction equal to the amount paid during the year.
Q: What pitfalls should I avoid?
A: In order to provide this benefit to your employees, the employer must have a written plan in place. This benefit is in addition to their taxable compensation and other benefits and as such, the employees cannot pick and choose this benefit instead of their taxable pay (or, for example, convert paid time off into this benefit).
It’s also worth noting that employees who would otherwise be eligible, but lack education expenses for reimbursement, cannot elect to receive other taxable compensation or benefits in lieu of participating in this program.
While this article covers some FAQs related to section 127 educational assistance programs, it is not all inclusive of the specifics and does not provide information on other types of educational assistance an employer could consider. Please reach out to your tax advisor for more details. Employer-provided educational assistance can provide another way for your business to attract and retain talent in today’s competitive market.
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This article was written by Anne Bushman, Nicole Kelley and originally appeared on 2021-06-08.
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