Employer-provided education benefits: section 132(d) is worth a second look.EXECUTIVE SUMMARY * MANY EMPLOYERS PROVIDE EMPLOYEES WITH TAX-FREE tax-free adj. Not subject to taxation; tax-exempt. tax-free Adjective not needing to have tax paid on it: a tax-free lump sum Adj. 1. education benefits. The two most common are scholarships and grants under IRC (Internet Relay Chat) Computer conferencing on the Internet. There are hundreds of IRC channels on numerous subjects that are hosted on IRC servers around the world. After joining a channel, your messages are broadcast to everyone listening to that channel. section 117 and education-assistance programs under section 127. There is, however, a third alternative: CPAs can recommend using the working condition fringe benefit fringe benefit Any nonwage payment or benefit granted to employees by employers. Examples include pension plans, profit-sharing programs, vacation pay, and company-paid life, health, and unemployment insurance. of IRC section 132(d). * SCHOLARSHIPS UNDER SECTION 117(a) ARE TAX-FREE if the recipient is a degree candidate at a qualified education institution and uses the funds for tuition For tuition fees in the United Kingdom, see . Tuition means instruction, teaching or a fee charged for educational instruction especially at a formal institution of learning or by a private tutor usually in the form of one-to-one tuition. , fees, books, supplies and equipment required for instruction. If the scholarships represent payments for past, present or future employment services, the employee must include them in income. * SECTION 127 ALLOWS EMPLOYERS TO OFFER up to $5,250 annually per employee in tax-free education help as long as the benefits are provided by reason of their employment relationship. This benefit covers graduate as well as undergraduate education undergraduate education Medtalk In the US, a 4+ yr college or university education leading to a baccalaureate degree, the minimum education level required for medical school admission; undergraduate medical education refers to the 4 yrs of medical school. Cf CME. but requires a formal written plan that must be open to everyone. These plans can be costly and burdensome for employers to administer. * UNDER SECTION 132(d) EMPLOYERS CAN OFFER a tax-free working condition fringe benefit for any expense employees can deduct de·duct v. de·duct·ed, de·duct·ing, de·ducts v.tr. 1. To take away (a quantity) from another; subtract. 2. To derive by deduction; deduce. v.intr. on their own tax returns under IRC section 162. This typically includes travel, meals and professional dues but also can include education that maintains or improves job skills or meets requirements for the employee to remain in his or her current position. * PROVIDING EDUCATION BENEFITS UNDER SECTION 132(d) is a good idea for employers because no written plan is required and there is no dollar limit on benefits. It is possible for employers to provide benefits under several different code sections at the same time. In general, though, section 132(d) is the most flexible alternative. Most employers consider their employees an important investment both to accomplish the organization's current goals and to have the right people in place for the future. Companies look to hire the best and the brightest and then give them the experience and education they need to advance through the ranks. Along with irreplaceable on-the-job on-the-job adj. Acquired or learned while working at a job: on-the-job training. Adj. 1. on-the-job experience, many experts have identified formal education as an important way to improve skills and gain knowledge and exposure to new ideas "New Ideas" is the debut single by Scottish New Wave/Indie Rock act The Dykeenies. It was first released as a Double A-side with "Will It Happen Tonight?" on July 17, 2006. The band also recorded a video for the track. . Employers have several tax-free options available to encourage workers to take advantage of education opportunities. The two most common are scholarships and grants under IRC section 117 and education-assistance programs under section 127. While both help employees, section 127 imposes dollar limits, and both plans bring administrative burdens on employers. A third alternative, part of the "working condition fringe benefit" of IRC section 132(d), receives little fanfare but provides the most flexibility with the fewest administrative headaches. This article offers CPAs the information they need to understand the options and counsel employers on the best alternatives for paying employee education expenses. SCHOLARSHIPS AND GRANTS Despite their popularity, scholarships and grants come with some restrictions. To exclude them from income under section 117(a), the recipient must be a degree candidate at a qualified education institution and use the funds for tuition, fees, books, supplies and equipment required for instruction. Employers have some leeway lee·way n. 1. The drift of a ship or an aircraft to leeward of the course being steered. 2. A margin of freedom or variation, as of activity, time, or expenditure; latitude. See Synonyms at room. as to the type of recipient; they may establish scholarships for employees, their spouses and children or even others not associated with the company, such as residents of the community where the company is located. However, when the scholarships are for an employee, CPAs should recommend caution to prevent the funds from becoming taxable. According to according to prep. 1. As stated or indicated by; on the authority of: according to historians. 2. In keeping with: according to instructions. 3. Treasury regulations section 1.117-4(c), if an employer pays for an employee's study or research, and those amounts represent payments rot rot (rot) 1. decay. 2. a disease of sheep, and sometimes of humans, due to Fasciola hepatica. rot decay. past, present or future employment services, the employee must include them in his or her income. Amounts that enable an employee to pursue studies or research primarily for the employer's benefit also are deemed taxable income Under the federal tax law, gross income reduced by adjustments and allowable deductions. It is the income against which tax rates are applied to compute an individual or entity's tax liability. The essence of taxable income is the accrual of some gain, profit, or benefit to a taxpayer. . Using the terms "scholarship" or "fellowship fellowship Graduate education A post-residency training period of 1–2 yrs in a subspecialty–eg, hand surgery, which allows a specialized physician to develop a particular expertise that may have a related subspecialty board; fellowship time is often grant" and funding education without some consideration of these rules may lead to undesired tax consequences. Indeed, the IRS An abbreviation for the Internal Revenue Service, a federal agency charged with the responsibility of administering and enforcing internal revenue laws. found its own scholarship program to be a taxable benefit in revenue ruling 76-230 because its student-trainees were receiving the education in exchange for future services. The courts found the taxpayers in Kreis Kreis, (plural Kreise, pronounced [kʁaɪs, ˈkʁaɪzə/span>]]) , is the German word for circle.
Austrian-born British psychoanalyst who first introduced play therapy and was the first to use psychoanalysis to treat young children. (32 TCM (1) (Trellis-Coded Modulation/Viterbi Decoding) A technique that adds forward error correction to a modulation scheme by adding an additional bit to each baud. TCM is used with QAM modulation, for example. 301 (1973)) to have taxable income because their education and research benefited their employers. In another situation employer-paid education was taxable and not considered a scholarship because future tuition assistance de pended on continued employment (revenue ruling 76-352). CPAs must examine closely, then, the relationship of the education to the employee's job and the employer's possible advantage to determine the tax stares of any scholarship. Some companies establish and fund private foundations to offer education grants and scholarships, and have those foundations select the recipients and handle disbursements. In those instances the recipient may exclude the grant from income under section 117(a) if it is "awarded on an objective and nondiscriminatory basis" and also meets other requirements of the foundation (see IRC section 4945(g) and Treasury regulations section 53.4945-4(a)(3)(ii)). EDUCATION-ASSISTANCE PROGRAMS In addition to scholarships and grants, another well-known well-known adj. 1. Widely known; familiar or famous: a well-known performer. 2. Fully known: well-known facts. method of providing education opportunities for employees is the assistance program under section 127. It allows an employer to offer up to $5,250 annually of tax-free education help to any employee who is currently employed, on leave, retired, disabled or laid off, as long as the benefits are provided by reason of their employment relationship. (Spouses and dependents are not covered not covered Health care adjective Referring to a procedure, test or other health service to which a policy holder or insurance beneficiary is not entitled under the terms of the policy or payment system–eg, Medicare. Cf Covered. .) In earlier years the $5,250 benefit was available only for undergraduate education and expired ex·pire v. ex·pired, ex·pir·ing, ex·pires v.intr. 1. To come to an end; terminate: My membership in the club has expired. 2. every few years, only to be reinstated each time by Congress. But for tax years beginning after December December: see month. 31, 2001, the benefit is permanent and covers graduate as well as undergraduate education. The extension to include graduate education is a welcome relief to many employees who want to pursue advanced or professional degrees using tax-free funds. Employees also do not have to be enrolled in degree programs, nor does the education have to be job-related. Section 127 education assistance programs can be quite costly and burdensome for employers to administer. For example, for each year of the program's existence, the employer must file form 5500 by the last day of the seventh month after the program yearend to report detailed plan information. The company also needs a formal, written plan, which qualifies only if the program meets all of these tests: * It is not discriminatory dis·crim·i·na·to·ry adj. 1. Marked by or showing prejudice; biased. 2. Making distinctions. dis·crim , that is, set up to favor highly compensated employees. * Not more than 5% of the program's benefits are for shareholders or owners. * It does not offer cash or other taxable benefits. * Reasonable notice of the program is given to eligible employees. (See IRS Publication 15-B, Employer's Guide to Fringe Benefits fringe benefits, n.pl the benefits, other than wages or salary, provided by an employer for employees (e.g., health insurance, vacation time, disability income). (January January: see month. 2004).) The requirement that the program be nondiscriminatory can make it costly depending on how many eligible employees take advantage of it. But section 127(b)(5) contains a relief feature: An employer is not required to fund an existing qualified education-assistance program. Thus, if a company has no available cash, it can put the plan on hold until cash flow improves. To reduce costs and influence the type of education workers pursue, a program may set certain eligibility requirements, such as covering only postgraduate education
Postgraduate education (often known in North America as graduate education, and sometimes described as quaternary education in its field of business, thereby limiting the number of employees eligible to participate. A recent letter ruling, for example, permitted a law firm to establish a plan that reimbursed the principal and interest on employees' law school student loans tax-free up to $5,250 per year under section 127 (letter ruling 200339017). The plan applied to all nonlawyer employees. THE WORKING CONDITION FRINGE BENEFIT A third alternative for providing education assistance is the working condition fringe benefit. While most of the tax-free education emphasis usually is on sections 117 and 127, the working condition fringe benefit is a choice that's actually much easier to implement and offers more flexibility as to which employees are eligible, what costs are covered and how companies can control them. IRC section 132(d) allows employers to offer a tax-free working condition fringe benefit for any business-related expense that employees could deduct on their individual tax returns under IRC section 162 if they themselves paid it. CPAs must look to section 162 for guidance on using this alternative. If that code section says an employee can deduct it, then section 132(d) opens it up as a possible benefit. In addition to allowing employees to deduct business expenses such as travel, meals and professional dues, section 162 permits a deduction deduction, in logic, form of inference such that the conclusion must be true if the premises are true. For example, if we know that all men have two legs and that John is a man, it is then logical to deduce that John has two legs. for job-related education expenses. Under Treasury regulations section 1.162-5(a), these expenses must meet the very familiar requirements of (1) maintaining or improving existing job skills or (2) meeting the express requirements necessary for taxpayers to remain in their current positions. Once an expense meets these requirements and the employee can deduct it, the employer may choose to offer tax-free reimbursement Reimbursement Payment made to someone for out-of-pocket expenses has incurred. , as most do for business travel expenses. In the case of tuition, if the employee receives reimbursement, or if the employer pays the school directly, the taxpayer can't take a deduction on his or her own return, as with any reimbursed expense. The two requirements described above have been the subject of numerous court cases and revenue rulings over the years. The most important theme that surfaces is that the education must be directly related to the employee's current duties rather than providing skills for a new position. An excellent case for CPAs to review is Blair Blair , Anthony Charles Lynton Known as "Tony" Born 1953. British lawyer, politician, and Labour Party leader who was elected prime minister in 1997. (41 TCM 289 (1980)), where the court examined each course in an MBA MBA abbr. Master of Business Administration Noun 1. MBA - a master's degree in business Master in Business, Master in Business Administration program and found the costs of all but one deductible That which may be taken away or subtracted. In taxation, an item that may be subtracted from gross income or adjusted gross income in determining taxable income (e.g., interest expenses, charitable contributions, certain taxes). because they related to the taxpayer's current position as a personnel manager. In Beatty Beatty is a surname of Scottish and Irish origin. In the Scottish case, it is derived from the name Bartholomew, which was often shortened to Bate. Male descendants were then often called Beatty, or similar derivations like Beattie or Beatey. (40 TCM 438 (1980)), the taxpayer, an aeronautical engineer Noun 1. aeronautical engineer - an engineer concerned with the design and construction of aircraft applied scientist, engineer, technologist - a person who uses scientific knowledge to solve practical problems with some management duties, was successful in deducting the cost of an MBA. But in reviewing other cases, CPAs will find the courts denied most taxpayers the education deduction because the courses either did not relate closely to their current position or qualified the taxpayer for a new position. Making a connection between the education and the current job is crucial to using the working condition fringe benefit to provide education benefits. The types of individuals considered employees for purposes of section 132(d) are somewhat limited, but contain a few surprises. Under Treasury regulations section 1.1321(b)(2), they include any * Individual the business currently employs. * Partner who performs services for the partnership. * Director of the employer. * Independent contractor A person who contracts to do work for another person according to his or her own processes and methods; the contractor is not subject to another's control except for what is specified in a mutually binding agreement for a specific job. who performs services for the employer. THE BENEFITS OF SECTION 132(d) The working condition fringe benefit offers flexibility for employers that wish to implement a simple plan or are experiencing difficult financial times but still want to offer some education benefits to certain employees. The often overlooked time- and money-savers include No written plan needed. There is no requirement for a written plan, nor must the employer notify employees about the benefit. The documentation is less than required for section 127 education-assistance programs, which require formal written plans and timely employee notification. Regulations section 1.132 5(c) says the only documentation necessary for reimbursing education expenses using section 132(d) is that which falls under the usual business-expense substantiation requirements of sections 162 or 274(d). This saves employers time in not having to draft, implement and maintain a formal written plan. it also means the company won't won't Contraction of will not. won't will not won't will lose its plan qualification because it misses a procedure. Discrimination feature. According to regulations section 1.132-5(q), the nondiscrimination non·dis·crim·i·na·tion n. 1. Absence of discrimination. 2. The practice or policy of refraining from discrimination. non rules applicable to other fringe benefit provisions do not apply to the working condition fringe benefit. The employer, therefore, may choose which employees it wants to reimburse re·im·burse tr.v. re·im·bursed, re·im·burs·ing, re·im·burs·es 1. To repay (money spent); refund. 2. To pay back or compensate (another party) for money spent or losses incurred. , including any highly compensated employees. A company could, for example, offer the benefit to employees it wants to single out for special treatment or move quickly up the corporate ladder. Since there are no reporting requirements, there's no need to spread the word to other employees. No dollar limit. Under section 127 education-assistance programs, the maximum annual tax free benefit is $5,250 per employee. However, section 162 requires only that expenses be "ordinary and necessary" as well as reasonable. That means a section 132(d) plan has virtually no limits. With today's high Today's High The intra-day high trading price. Notes: In other words, this is the highest price that a stock traded at during the course of the day. More often than not this is higher than the closing price. See also: Today's Low tuition costs, enrolling in just a few courses during the year may easily exceed $5,250. Thus the working condition fringe benefit gives employers the option of paying more. Other education expenses allowed. Section 162 allows more types of expenses than education-assistance programs under section 127 or scholarships under section 117. Both those sections allow deductions for tuition, fees, books, supplies, tools and equipment, but Treasury regulations section 1.162-5 (c) extends the deductible amounts to include meals, lodging Lodging or holiday accommodation is a type of accommodation. People who travel and stay away from home for more than a day need lodging mainly for sleeping. Other purposes are safety, shelter from cold and rain, having a place to store luggage and being able to take a and transportation expenses if the employee travels away from home to obtain education that qualifies for the deduction. THE DRAWBACKS No plan is perfect, though, and the working condition fringe benefit approach of section 132(d) does bring several special challenges for CPAs. From the employer's perspective, the first is the political issue of which employees should receive the benefit. The top management of large companies or the owners of smaller businesses will need to at least informally set the rules and conditions of who is eligible. This could be a problem in larger companies when managers of various divisions begin asking for the benefits to apply to certain of their employees. Even though there is no requirement to notify employees about the plan, word usually leaks out and the plan could become a negative influence on worker morale. While companies don't need a written plan to offer education benefits under section 132(d) and the only necessary substantiation appears to be to meet the regular business deduction Noun 1. business deduction - tax write-off for expenses of doing business entertainment deduction - deduction allowed for some (limited) kinds of entertainment for business purposes requirements (amount, time and date, place and business purpose), a close link to the employee's current job also is mandatory. In some cases the courts evaluate each university course to see whether it specifically relates to the employee's current position. CPAs must be ready to help employers and clients establish a "direct and proximate proximate /prox·i·mate/ (prok´si-mit) immediate or nearest. prox·i·mate adj. Closely related in space, time, or order; very near; proximal. proximate immediate; nearest. relationship" between the education and the current job requirements, as mentioned in McAuliffe (40 TCM 420 (1980)). Establishing such a relationship may involve reviewing and perhaps updating job descriptions so they present a more accurate and complete list of skills required for the position. These rules are much stricter than those for scholarships, grants and section 127 plans, which do not require that course work be closely related to job function. INTERPLAY in·ter·play n. Reciprocal action and reaction; interaction. intr.v. in·ter·played, in·ter·play·ing, in·ter·plays To act or react on each other; interact. OF CODE SECTIONS CPAs will find it is possible for an employer to fund employee education under more than one code section at the same time (see exhibit at left). In good financial times, employers with existing education-assistance programs under section 127 might wish to offer greater tax-free benefits than the $5,250 maximum. Fortunately, section 1320)(8) allows for the exclusion of payments in excess of the $5,250 maximum if they qualify as a working condition fringe benefit. Employers have the flexibility of using the working condition fringe benefit even when combining section 127 and section 132(d) programs (letter ruling 9418010). While employees in general are subject to the $5,250 annual section 127 maximum, certain ones may receive greater benefits under section 132(d). Alternatively, when the company doesn't fund section 127 programs during a particular year, it still may use section 132(d). Tuition-reduction plans. Many colleges and universities allow employees and their families to enroll in courses at either reduced tuition rates or, more commonly, at no cost at all. These section 117(d) plans, however, represent a conflict with section 132. Section 117(d) says an institution's employees (including spouses and children) do not have to include tuition reduction below the graduate level in their gross income. Since only undergraduate tuition reduction is tax-tree, some taxpayers were hoping graduate tuition reduction might qualify as a working condition fringe benefit much as excess payments above the section 127 maximum qualify. Field service advice (FSA FSA Financial Services Authority FSA Food Standards Agency (UK) FSA Farm Service Agency (USDA) FSA Financial Services Agency (Japan) ) 200231016 addressed this issue and found graduate tuition reduction is not a working condition fringe benefit. The IRS reasoned that a school offering free or reduced tuition when one of its own employees takes a course at the institution is not the same as an employer's actually paying cash under a section 127 education-assistance plan. This distinction is important because if, for example, a school pays cash to reimburse an employee for graduate tuition while he or she is enrolled at a different school, the reimbursement may be a working condition fringe benefit. On the other hand a school simply filling an empty graduate-level seat in one of its own classrooms as a noncash perk perk 1 v. perked, perk·ing, perks v.intr. 1. To stick up or jut out: dogs' ears that perk. 2. To carry oneself in a lively and jaunty manner. is not a working condition fringe benefit. One of the possible rationales in the FSA for this approach is that "there is little incentive to monitor whether graduate level courses are job related when the courses result in no additional cost to the employer." Actually paying cash to another school presumably pre·sum·a·ble adj. That can be presumed or taken for granted; reasonable as a supposition: presumable causes of the disaster. results in greater scrutiny of the reasons for the payments and the relationship of the courses to the employee's job. A FLEXIBLE BENEFIT There are various ways employers can provide tax-free education help to employees--each with advantages and disadvantages. Scholarships and grants and section 127 education-assistance plans have limitations. However, using the working condition fringe benefit provision offers employers flexibility and requires less time, paperwork and effort, especially in times of financial hardship or when the goal is to reward a small segment of employees. Flexibility and cost control from section 132(d) plans may be just the incentive employers need to finance graduate degrees for select employees. The key to making the working condition fringe benefit method work is to ensure that the courses in which employees enroll are very closely related to their current jobs. Armed with this array of tax-free education benefit options, CPAs can advise employers and clients on the alternative that best meets their needs.
Comparing Education Benefit Options
Education- Working
Scholarships assistance condition
and grants programs fringe benefit
section 117(a) section 127 section 132(d)
Plan must be
nondiscriminatory Yes Yes No
Student must be
degree candidate Yes No No
Education must be
job-related No No Yes
Requires formal
written plan Yes Yes No
Requires employee
notification Yes Yes No
Imposes dollar limit No Yes No
Covers travel expenses No No Yes
All Help Appreciated For the 2003-2004 academic year * The average cost of tuition and fees at a private four-year college was $19,710, up 6% from the previous year. * Tuition and fees at the average public institution rose 14.1% to $4,694. * The cost of attending a two-year public institution increased to $1,905, up 13.8%. Source: College Board, www.collegeboard.com PRACTICAL TIPS TO REMEMBER * To prevent funds from becoming taxable, recommend caution when employers offer scholarships to employees. If the amounts represent payments for past. present or future employment services, employees must include them in their income. Companies should consider setting up private foundations to award scholarships on an objective and nondiscriminatory basis. * Point out to employers that qualified education-assistance pro grams under IRC section 127(b)(5) include an important relief feature. If the program already exists, the employer is not required to fund it. This means cash-strapped companies can put the plan on hold until better financial times return. * Remind employers and employees that making a connection between the education and the current job is crucial to using the working condition fringe benefit. By reviewing past litigation An action brought in court to enforce a particular right. The act or process of bringing a lawsuit in and of itself; a judicial contest; any dispute. When a person begins a civil lawsuit, the person enters into a process called litigation. , CPAs will find the courts have denied most education deductions either because the courses did not closely relate to employees' current positions or qualified them for new positions. EDMUND D. FENTON JR., CPA (Computer Press Association, Landing, NJ) An earlier membership organization founded in 1983 that promoted excellence in computer journalism. Its annual awards honored outstanding examples in print, broadcast and electronic media. The CPA disbanded in 2000. , DBA, is professor of accounting at Eastern Kentucky University Student Life The Eastern Kentucky University Office of Student Life works closely with Registered Student Organizations (RSO's), Greek Life, and Thursday Alternative Getaway (TAG). in Richmond. His e-mail address See Internet address. e-mail address - electronic mail address is ed.fenton@eku.edu. |
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