The IRS has issued a new fact sheet (FS-2024-22) to address frequently asked questions about educational assistance programs (EAPs), also known as Section 127 plans.1 EAP plans have been an effective recruitment and retention tool for many employers over the past two decades and remain popular with employees because the payments are tax exempt to employees and tax deductible to employers.
In order for payments made under an EAP to be tax-free to employees, the EAP must:
- Provide benefits exclusively to employees of the employer;
- Comply with non-discrimination rules that prohibit discrimination in favor of highly compensated employees;
- Limit benefits provided in any given calendar year to individuals deemed to own 5% or more of the company so that those benefits do not exceed 5% of total benefits provided;
- Provide benefits only for tuition, books, fees and supplies/equipment that the employee may not keep upon completion of the course;
- Be established pursuant to a separate written document;
- Prohibit an employee from electing cash (or other taxable compensation) in lieu of educational assistance; and
- Provide no more than $5,250 of excluded educational assistance to an employee with respect to any given calendar year.
The FAQs include nine questions and answers about EAPs, including the requirements for an EAP, what qualifies as educational assistance, and the amount excludable from taxation under an EAP. The FAQs also specifically address reimbursement for student loans or debt related to educational expenses, which Congress added to EAPs for payments made after March 27, 2020, and before January 1, 2026. Employers may pay the principal or interest on qualified student loan debt if the EAP as written includes language allowing for such payments. FAQ 5 explains: "If the plan is currently written to provide generally for all benefits provided under section 127, then it is possible that the plan would not need to be amended to provide for the qualified education loan benefit under section 127(c)(1)(B)."
The FAQs further clarify that such loan reimbursements are not available to spouses or dependents because an EAP must be exclusively for employees.2 The FAQs also explain that while self-employed individuals may be eligible to set up an EAP, "as a practical matter, if the owners are the only employees, they cannot receive educational assistance under section 127 because of the 5 percent benefit limitation ...."3
Because FAQs are general guidance, they are not binding and may not cover a particular employer's fact pattern or plan document and will not be relied upon by the IRS to resolve any particular taxpayer issue. Further,
if an FAQ turns out to be an inaccurate statement of the law as applied to a particular taxpayer's case, the law will control the taxpayer's tax liability. Nonetheless, a taxpayer who reasonably and in good faith relies on these FAQs will not be subject to a penalty that provides a reasonable cause standard for relief, including a negligence penalty or other accuracy-related penalty, to the extent that reliance results in an underpayment of tax.4
While it remains to be seen what happens with tax reform in 2025 (given the expiration of the Tax Cuts and Jobs Act on December 31, 2025), EAPs remain popular, including the expansion to include student loan debt. Efforts to increase the $5,250 cap, which has not changed since enactment and has been substantially eroded by inflation, have failed to date. Making the provisions on students loans permanent and raising the $5,250 limit are likely to be part of the tax reform debates next year.
Nonetheless, employers without an EAP should consider whether to implement one, and employers that already have an EAP should review it if they want to ensure that it is broad enough to cover payments on student loan debt.
Footnotes
1 Educational assistance plans are not the only form of tax-favored educational reimbursement that an employer can provide. Educational assistance can also be provided if as a working condition fringe benefit, the (1) the educational expense maintains or improves the skills required in the employee's trade or business as an employee solely for the benefit of the employer or (2) the educational requirements are mandated by the employer as a condition for the employee to retain employment and the mandate is for a bona fide business purposes. There is no limit on the amount of a working condition fringe benefit, in contrast to an educational assistance program. Notwithstanding the above, the educational expense will not qualify as a working condition fringe if the expense either (a) is needed for the employee to meet the minimum requirements for qualification in the job or (2) is part of a program of study that will qualify the employee for another trade or business. See 26 U.S.C. § 132(a)(3), (d). The IRS FAQs briefly address working fringe benefits in FAQ 9.
2 FAQ 6.
3 FAQ 8.
4 FS-2024-22.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.