Tax Edge

By Robert Steere, Toolkit Staff Writer

Summer is flying by, and already a new school year is just around the corner. And now, after a bit of a summer break, many of us in the business world are looking ahead to the start of a fresh semester of classes so that we can continue to build our knowledge and skills and enhance our professional value. Those who are fortunate have an employer eager to help with these academic pursuits.

If you are an employer seeking to support your employees in their pursuit of continuing education, you can get some help from Uncle Sam by establishing an educational assistance program within your business. Through such a program, you can deduct the educational assistance benefits provided to employees as a business expense. Even better, up to $5,250 of this assistance each year can be excluded from each employee's taxable wages. This means the educational assistance (up to $5,250) would not be included in the employee's wages, tips, and other compensation shown in box 1 of the Form W-2. It also means that your employee does not have to include the benefits in his or her income tax return.

Tax-free educational assistance benefits are the amounts paid by the employer for the employees' qualifying education expenses. Generally, these expenses include the cost of tuition, fees and similar expenses, books, supplies, and equipment. The payments may be for either undergraduate or graduate courses. The payments do not have to be for work-related courses. However, educational assistance benefits do not include payments for the following items:

• Meals, lodging, or transportation;
• Tools or supplies (other than textbooks) that can be kept after completing the course; or
• Tuition for courses involving sports, games, or hobbies, unless they have a reasonable relationship to the employer's business or if they are required as part of a degree program.

An employer that pays more than $5,250 for educational assistance benefits to any employee during the year must generally include the excess amount in the employee's wages (Form W-2, box 1), and the employee must include the excess amount in taxable income when filing his or her tax return. There is an exception to this general rule if the benefits in excess of $5,250 also qualify as working condition fringe benefits. A working condition fringe benefit is a benefit which, if paid by the employee, would be deductible as an employee business expense. In that case, the employer does not have to include such amounts in the employee's wages.

It is important to note that work-related education expenses generally would fall into this tax-free category of working condition fringe benefits, whether or not there is an educational assistance program. If the education is required by the employer or by law and it serves a bona fide business purpose of the employer, or if it maintains or improves skills needed in the job, it will typically, but not always, be a working condition fringe benefit.

One more important caution for employees receiving benefits from an educational assistance program - the educational expenses paid for by your employer cannot serve as the basis for taking the Hope credit, the lifetime learning credit, the deduction for tuition or any other deduction or credit on your individual tax return.

To qualify for the special tax treatment, an educational assistance program must be a written plan for the provision of educational assistance only to your employees (former employees can be included if their employment is the reason for the coverage). It must meet all of the following tests:

• The program rules and eligibility requirements must not favor highly compensated employees (to determine whether your program meets this test, disregard employees excluded from the program who are covered by a collective bargaining agreement if there is evidence that educational assistance was a subject of good-faith bargaining);
• The program must not provide more than 5 per cent of its benefits during the year for shareholders or owners. A shareholder or owner is someone who owns (on any day of the year) more than 5 per cent of the stock or capital, or interest in profits of your business;
• The program must not allow employees to choose to receive cash or other benefits that must be included in gross income in lieu of receiving educational assistance; and
• Reasonable notice of the program must be given to all eligible employees.

For purposes of these tests, a highly compensated employee is an employee who either was a 5 percent owner at any time during the year or the preceding year, or received compensation in excess of $105,000 for the preceding year. The compensation test can be ignored if the employee was not also in the top 20 percent of employees when ranked by pay for the preceding year.

Furthermore, for purposes of these tests, the term "employee" includes a current employee; a former employee who retired, left on disability, or was laid off; a leased employee who provided services on a substantially full-time basis for at least a year, if the services were performed under the employer's primary direction or control; the proprietor, if a sole proprietorship; and any partner who performs services, if a partnership.

More information on employer educational assistance programs and working condition fringe benefits can be found in Chapter 2 of Publication 15-B, Employer's Tax Guide to Fringe Benefits. Check it out to find out more about how you can help your employees pursue their educational goals.

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Posted July 29, 2009.