It’s Easy To Set Up A Plan That Provides Employees With Tax-Free Income For Student Loan Repayments

The CARES Act passed in 2020 allows employers to provide tax-free compensation of up to $5,250 per year to their employees for qualified educational expenses, including student loans. As tax-free compensation, this benefits both the employer and employee. The employee gets tax-free income. The employer gets the business deduction but pays less payroll taxes by not reporting the tax-free income. For employees in high tax brackets, this can result in a tax savings of over $1,000 per year.

But I suspect that not many employers took advantage of this. Anecdotally, people have told me that they did not know about this plan. And those that did thought that implementing the plan would be too much of a hassle or that most of their employees would be ineligible because they are highly compensated.

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Today’s column will show you that it’s not hard to set up an educational assistance plan that provides tax-free income to employees. A company simply has to have a written plan and make adjustments to their payroll reporting.

First, there must be a written plan detailing the educational assistance plan. But the document does not have to be long or complex. The written plan at a minimum must list the terms of the plan to qualify for the tax benefit. They include the following:

• Who is eligible and ineligible for the program. Spouses and dependents of employees are ineligible. Also, the plan must not be set up to favor highly compensated employees.
• What expenses are eligible and ineligible.
• Those who hold more than 5% of the company’s ownership interest are not allowed to receive assistance exceeding 5% of the total amounts paid under this plan.
• The plan must state that it does not offer other taxable benefits or compensation that can be chosen instead of educational assistance payments.
• Employees do not need to contribute money to be eligible for benefits.

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The written plan does not have to be submitted to the IRS for approval. However, it is recommended to have a professional review a proposed plan to see if it meets statutory requirements.

Lastly, employers should provide reasonable notice of the plan to all employees.

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Some businesses think that they do not qualify because most or all of their employees are highly compensated employees (HCE). Generally, HCEs are those employees who earn more than $130,000 per year in 2021 and rank in the top 20% in terms of compensation. This is a misunderstanding. The law does not state that HCEs are ineligible for the tax-free benefits. Instead, it states that a plan that discriminates in favor of HCEs is ineligible. The simplest way to get around this limitation is to make this plan available to all company employees with no restrictions.

Assuming both the employer and employee meet all of the requirements, the eligible reimbursements up to $5,250 will be excluded from taxable income on the employee’s W-2 as well as on the employer’s payroll tax returns.

There is a small trap. If the employer paid the employee’s student loan interest payment, then the employee cannot take the student loan interest deduction if they are otherwise eligible. To get around this, the employee should pay any accrued student loan interest up to the statutory maximum of $2,500.

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Unfortunately, this benefit is not available to solo practitioners because they own more than 5% of their business. Even those who are employees of a corporation that they own. If the solo practice has employees, then they could be eligible for the benefit but not more than 5% of the total amounts paid under the plan.

Right now, student loan repayment perks are the new hotness when it comes to employee hiring. It is easy to set up a plan that allows a company to provide tax-free income to employees who are paying student loans. I have provided a sample Educational Assistance Plan document that your business can use to design your company’s plan. If employers act quickly, it is possible to take advantage of the benefit before the end of the year. Your indebted employees will thank you for it.

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Steven Chung is a tax attorney in Los Angeles, California. He helps people with basic tax planning and resolve tax disputes. He is also sympathetic to people with large student loans. He can be reached via email at [email protected]. Or you can connect with him on Twitter (@stevenchung) and connect with him on LinkedIn.

Topics

Steven Chung, Student Loans, Tax Law