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Tax Breaks for Employer-Paid Education Expenses

Is your business struggling with a shortage of skilled workers in today’s tight labor market? One possible option is to invest in education programs to upskill your current employees. This strategy can help bridge the gap at your workplace and build loyalty among workers. Plus, the education may qualify for favorable treatment. Here are some possible options for employers and the related tax rules.

Reimbursements for Job-Related Qualified Education Expenses

An employer can give its employees unlimited tax-free reimbursements to cover qualified education expenses. In a nutshell, qualified education expenses are for education that:

  • Is required by the employer or by law or regulation to retain an employee’s current job, or
  • Maintains or improves skills needed for an employee’s current job.

The company can also directly pay qualified education expenses on an employee’s behalf with the same favorable tax treatment. Such reimbursements or payments are tax-deductible and not subject to federal payroll taxes.

Important: Qualified education expenses don’t include costs for education that qualify an employee for a new occupation or profession. If an employer pays for that kind of education, the payments count as additional taxable compensation for the employee, subject to income and payroll taxes – unless they’re run through a Section 127 educational assistance plan.

Educational Assistance Plans

An employer can offer a Sec. 127 educational assistance program that gives each participating employee up to $5,250 in annual tax-free reimbursements. The employer can deduct the costs of operating a Sec. 127 plan as a business expense without owing any federal payroll taxes.

The tax rules permit these plans to cover just about anything that constitutes education, including graduate coursework, whether it’s job-related or not. There are only two tax-law restrictions:

  1. The education must be for the employee, rather than another member of the employee’s family, and
  2. The plan can’t pay for courses involving sports, games, or hobbies unless they relate to company business.

Plans may reimburse employees only for education that’s job-related. What’s reimbursable is left to the employer’s discretion when setting up the plan. Some companies don’t do a good job of publicizing their Sec. 127 plans. So, if you do implement one, be sure to notify and remind employees about it, urging those interested to contact the HR department for more information.

As a bonus, Congress enacted legislation in 2020 that allows federal-income-tax-free treatment for payments made by employer-sponsored Sec. 127 educational assistance plans toward student loan debts of participating employees. This deal covers payments made under Sec. 127 plans through December 31, 2025. The annual limit is $5,250 for any combination of education expenses and student loan payments.

For More Information

If your company has employees who want to take their skill sets to the next level, consider reimbursing education costs as a fringe benefit or setting up an educational assistance program. Doing so can keep your workers well-trained and save taxes, too. Contact your tax advisor to ensure you’ll enjoy the tax advantages of employer-provided education benefits.