The Current Tax Status of Employer Education Assistance

The Current Tax Status of Employer Education Assistance

Order Code 97-243 EPW
Updated January 14, 2005
CRS Report for Congress
Received through the CRS Web
The Current Tax Status of
Employer Education Assistance
Linda Levine and Bob Lyke
Domestic Social Policy Division
Summary
Section 127 of the Internal Revenue Code allows up to $5,250 in tuition
reimbursements and other forms of employer education assistance (e.g., books, supplies,
and equipment) to be exempt from income and employment taxes even if the education
does not qualify as a deductible business expense. The Economic Growth and Tax
Relief Reconciliation Act of 2001 (P.L. 107-16) reinstated the exclusion for graduate-
level courses that begin after December 31, 2001. As with many other provisions in that
legislation, the exclusion is extended only through December 31, 2010.
Taxable Employer Education Assistance
Except as discussed below, education assistance from employers generally must be
included in employees’ gross income for federal income tax purposes. The amount is
reported on the W-2 statement that employees receive each January. Employers typically
increase withholding for the additional income taxes employees owe. The assistance also
is subject to Social Security and Medicare taxes, for which withholding is increased as
well, and to unemployment taxes paid only by employers.
Deductible Business Expense
Education assistance from employers can be tax-exempt if the education meets
Internal Revenue Service (IRS) tests for a deductible business expense. Essentially, these
tests require that the education be job-related but not enable one to meet minimum
requirements for current work or prepare for a new career. The tests consist of four
questions displayed on the flow chart below.1 Employer tuition reimbursements can be
excluded from employees’ gross income if the education meets the IRS tests and they are
provided through an accountable plan (i.e., employees are required to substantiate
reimbursements to their employer and return any excess payments). If an accountable
plan does not exist, the assistance is included in employees’ gross income; however,
1 IRS regulations 1.162-5. For additional information, see Your Federal Income Tax (IRS
publication 17) and Tax Benefits for Education (publication 970).
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CRS-2
taxpayers who itemize their deductions may be able to deduct some portion, provided the
education meets the four-question IRS tests. With some exceptions, such deductions are
limited to the amount that the assistance plus other miscellaneous deductions exceeds 2%
of adjusted gross income. Thus, they might not offset all or even any of the expense.
Are Education Expenses Deductible?
Is the education needed to meet minimum
yes
educational requirements of taxpayer's trade or
business?
not
no
deductibl e
Is the education part of a study program that
can qualify the taxpayer for a new trade or
yes
business?

no
Is the education required by the employer or
yes
by law to keep taxpayer's present salary,
status, or job?
no
deductible
Does the education maintain or improve skills
no
yes
required in doing taxpayer's present work?
Employer Education Assistance Exclusion
Section 127 allows taxpayers to exclude from gross income up to $5,250 a year in
education assistance from their employer even if the education does not meet the above-
described IRS tests. Courses do not have to be job-related; they can also help employees
meet minimum requirements for current work or prepare for a new career. For the
exclusion to apply, employer education assistance programs must have separate written
plans, employee notification, and restrictions against favoring highly compensated
employees. Education involving sports, games, or hobbies is not covered unless these
activities are the business of the employer or the courses are part of a degree program.
Graduate-level courses were not covered between June 30, 1996 and December 31,
2001. P.L. 107-16 reinstated coverage for graduate-level courses beginning after
December 31, 2001. It also extended the exclusion through December 31, 2010.
Taxpayers who receive employer education assistance not excluded or deducted as
described above might be eligible for either the Hope Scholarship credit, the Lifetime
Learning credit, or the tax deduction for higher education expenses.2
In January 2005, the Joint Committee on Taxation estimated that the tax expenditure
(i.e., the aggregate difference in tax liability) attributable to the exclusion for employer
education assistance will be approximately $0.8 billion in FY2005.
2 For more information, see CRS Report RL31129, Higher Education Tax Credits and
Deduction: An Overview of the Benefits and Their Relationship to Traditional Student Aid, by
Adam Stoll and James B. Stedman.