A Brief Overview of Qualified Educational Assistance Programs

Education expenses can be paid by an employer for its employees as a tax-free benefit under Tax Code Section 127, provided the following requirements are met:

1.  There must be a written document setting forth the terms of the educational assistance program.

2.  The maximum annual tax-free benefit is $5,250 per employee.

3.  Only employees or former employees of the employer may participate.

4.  The program must not be discriminatory in availability in favor of highly compensated employees--that is, eligibility requirements cannot be imposed that make it easier for the highly paid to use the program than the non-highly paid. Two things to note:

1. Actual use of the program is not tested--only the availability. (For example, a plan would not be discriminatory if all employees are eligible to participate but only highly compensated employees actually use it.)
2. Employees under a collective bargaining agreement can be excluded from this requirement.

5.  No more than 5% of the total amounts paid by the employer under the plan can go to individuals who own more than 5% of the employer.

Owners of 5% or less of the employer are not limited.

The 5% of the total amount paid is applied to the entire group of more than 5% owners. For example, if total payments for the year are $10,000, only $500 in total could be paid to the owner group. The other $9,500 would have to be paid to non-owners (or owners of 5% or less).

Ownership attribution rules apply. For example, the children of a person who owns more than 5% of the employer will be treated as also owning more than 5% of the employer.

6.  Reasonable notification of the availability and terms of the program must be provided to eligible employees.

7.  Employees may not be given a choice between educational assistance and other payments. For example, an employee cannot be given a choice between $2,000 in cash versus the employer paying a $3,000 tuition bill--this would cause the payment of tuition to be taxable to the employee (in the full amount of the $3,000 tuition).

8.  Payment must be for "educational assistance".

1. This includes tuition, fees, textbooks, and in-class supplies and equipment.
2. This does not include tools or supplies which may be retained by the employee after completion of the course. (For example, if an employee purchased a financial calculator to assist with a class and retained the calculator after the class, it would not be eligible.)
3. This also does not include meals, lodging, or transportation.
4. Finally, this does not include any course or other education involving sports, games or hobbies.
5. Subject to the limitation on sports, games, and hobbies, the education does not have to be work-related or part of a degree program.

9.  Payments can be made directly to the education provider, by reimbursement to the employee, or "in kind" (that is, the employer can offer educational courses itself).

10.  Subject to the nondiscrimination rules, an employer can limit the types of education benefits offered or impose other requirements (for example, requiring employer pre-approval of a course to be taken or requiring a minimum grade to be received in order to be reimbursed).

11.  Provided the employer does not set aside a specific fund or account from which to make payment under the plan, ERISA generally would not apply. (Consequently, most employers would want to make payments out of the employer's general assets rather than creating a separate payment fund.)

12.  In 2002, the IRS suspended the requirement for educational assistance programs to file an annual report. Consequently, assuming ERISA does not apply to the program, no Form 5500 or other federal filing is required.