July 2024

The Internal Revenue Service (IRS) has issued frequently asked questions (FAQs) that provide general information on educational assistance programs under Section 127 of the Internal Revenue Code (Code).

Under a Section 127 educational assistance program, employers can provide their employees with up to $5,250 per year toward qualified educational expenses without the benefits becoming taxable income to the employee. In addition, amounts paid under a Section 127 educational assistance program are generally deductible by the employer as a business expense.

In order to provide this benefit to employees, employers must have a written educational assistance plan that meets certain content requirements. The IRS issued these FAQs to provide general information to taxpayers and tax professionals.This Compliance Overview contains the IRS FAQs in their entirety.

What is an educational assistance program?

An educational assistance program is a separate written plan of an employer for the exclusive benefit of its employees to provide employees with educational assistance.

To qualify as a Section 127 educational assistance program, the plan must be written and meet certain other requirements. An employer can tell its employees whether there is a Section 127 educational assistance program where they work.

A sample plan for employers is available. An employer may tailor its plan to include, for example, conditions for eligibility, when an employee’s participation in the plan begins and prorated benefits for part-time employees. However, a program cannot discriminate in favor of officers, shareholders, self-employed, or highly compensated employees in requirements relating to eligibility for benefits. 

What are educational assistance benefits?

Tax-free educational assistance benefits under a Section 127 educational assistance program include payments for tuition, fees and similar expenses, books, supplies and equipment. The payments may be for either undergraduate- or graduate-level courses. The payments do not have to be for work-related courses.

Tax-free educational assistance benefits also include principal or interest payments on qualified education loans (as defined in Section 221(d)(1) of the Code). Section 127 requires that such loans be incurred by the employee for the education of the employee and not for the education of a family member such as a spouse or dependent. These payments must be made by the employer after March 27, 2020, and before Jan. 1, 2026 (unless extended by future legislation). The payments of any qualified education loan can be made directly to a third party, such as an educational provider or loan servicer, or directly to the employee, and it does not matter when the qualified education loan was incurred. A qualified education loan is generally the same as a qualified student loan. See Qualified Student Loan in Chapter 4 of Publication 970, Tax Benefits for Education.

Educational assistance benefits do not include payments for the following items:

• Meals, lodging or transportation.
• Tools or supplies (other than textbooks) that an individual can keep after completing the course of instruction (for example, educational assistance does not include payments for a computer or laptop that one keeps).
• Courses involving sports, games or hobbies unless they:
  • Have a reasonable relationship to the business of the employer, or
  • Are required as part of a degree program.

An employer may choose to provide some or all of the educational assistance described above. The terms of the plan may limit the types of assistance provided to employees.

What is the total amount that an employee can exclude from gross income under Section 127 of the Code per year?

Under Section 127, the total amount that an employee can exclude from gross income for payments of principal or interest on qualified education loans and other educational assistance combined is $5,250 per calendar year. For example, if an employer pays $2,000 of principal or interest on any qualified education loan incurred by the employee for the education of the employee, only $3,250 is available for other educational assistance. 

The annual limit applies to amounts paid and expenses incurred by the employer during a calendar year. If an employee seeks reimbursement for expenses incurred, the expenses must be paid by the employee in the same calendar year for which reimbursement is made by the employer, and the expenses must not have been incurred prior to employment (however, qualified education loans may be incurred by the employee in prior calendar years and prior to employment, and payments of principal and interest may be made by the employer in a subsequent year). “Unused” amounts of the $5,250 annual limit cannot be carried forward to subsequent years. 

What is a qualified education loan?

A qualified education loan (as defined in Section 221(d)(1)) is a loan for education at an eligible educational institution. Eligible educational institutions include any college, university, vocational school or other postsecondary educational institution as defined in Sections 221(d)(2) and 25A(f)(2). The Department of Education determines whether an organization is an eligible education institution. A loan does not have to be issued or guaranteed under a Federal postsecondary education loan program to be a qualified education loan. 

How can payment of qualified education loans be made?

In the case of payments made after March 27, 2020, and before Jan. 1, 2026 (unless extended by future legislation), depending on how a particular employer has designed its Section 127 educational assistance program, an employer may provide payments of principal or interest on an employee’s qualified education loans (as defined in section 221(d)(1) of the Code) for the employee’s own education directly to a third party, such as an educational provider or loan servicer, or make payments directly to the employee.

Generally, the payment by an employer of principal or interest on any qualified education loan incurred by the employee for the education of the employee under Section 127(c)(1)(B) is only available if an employer amends the terms of its plan to include the benefit. 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). 

Are employer payments of qualified education loans for spouses and dependents excluded from gross income under Section 127 of the Code?

Under Section 127 of the Code, an educational assistance program must be provided for the exclusive benefit of employees. A program that provides benefits to the spouse or dependents (as defined in Section 152) of an employee is not a Section 127 educational assistance program. Spouses and dependents of employees who are also employees may receive benefits under the program, but they are subject to a rule that prohibits discrimination in favor of these employees in requirements relating to eligibility for benefits, and to a rule that limits the benefits that may be provided to them under the program to 5% of the benefits under the program.