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Using a Qualified EAP
Editor:
Editor’s note: This case study has been adapted from PPC Tax Planning GuideClosely Held Corporations, 16th Edition, by Albert L. Grasso, Joan Wilson Gray, R. Barry Johnson, Lewis A. Siegel, Richard L. Burris, James A. Keller, Gary W. Brown and James J. Mogelnicki, published by Practitioners Publishing Company, Ft. Worth, TX, 2003 ((800) 323-8724; www.ppcnet.com).
Facts: Hastings Electronics has established a qualified educational assistance program (EAP) that meets Sec. 127s requirements. Hastings encourages its employees to pursue degree courses at the local university and professional development seminars in fields of career or educational interest. For degree courses, Hastings reimburses 100% of tuition and related expenses if the employees grade transcript shows he or she earned a B or higher. For professional development seminars, Hastings reimburses 100% of registration, travel and related expenses if the employee provides a statement of attendance and participation. During the year, the following activity occurred under the plan (Hastings reimbursed all amounts). Payroll clerk Sally Jones used extended vacation leave to pursue an education degree at Private College. (Currently, Sally does not have a college degree and wants to be a math teacher.) She completed 30 hours of course work; Hastings paid $6,000 to Private College. Sally also attended a one-week payroll seminar during the year. Registration, course materials and travel costs were $2,000. Sally adequately substantiated her expenses and Hastings reimbursed her. Technician
Jeff Cooper incurred $500 in educational expenses to attend a local
seminar on computer software programming. Although the seminar topic was
not related to his current job, Jeff hopes to become an independent
computer programmer. Issue: Do these reimbursements qualify as educational assistance under the companys qualified EAP?
Analysis Employers can annually provide each employee with up to $5,250 of tax-free educational assistance if the employer establishes a formal EAP that meets Sec. 127s requirements. The exclusion includes graduate-level courses beginning after 2001. According to Sec. 127(b), the EAP must: 1. Be in writing. 2. Not discriminate in favor of highly compensated employees (as defined in Sec. 414(q)) or their dependents. 3. Not pay more than 5% of program benefits to more-than-5% shareholders or owners (or their spouses or dependents). 4. Provide educational assistance exclusively to employees. 5. Not provide eligible employees with a choice between educational assistance and taxable remuneration. 6 Provide reasonable notice of the programs availability and terms to eligible employees. The first $5,250 of qualified educational assistance provided during the calendar year under a Sec. 127 program is exempt compensation for Federal in-come tax, FICA and FUTA purposes. If the qualified EAP fails the Sec. 127 requirements, all payments are taxable employee compensation under Regs. Sec. 1.127-1(c), unless exempt under some other Code provision (e.g., as a working-condition fringe benefit (WCFB) or a qualified tuition reduction).
Reimbursable Expenses According to Sec. 127(c)(1)(A), reimbursable expenses under a qualified EAP include tuition, fees, books, equipment, supplies and costs of any courses that instruct employees, as long as the education does not involve the use of athletic facilities or equipment and is not recreational in nature. However, Regs. Sec. 1.127-2(c)(3) excludes from reimbursable expenses the costs of the following:
According to Regs. Sec. 1.127-2(e)(2)(ii), employers can condition payment of benefits on successful course completion, attainment of a minimum grade (e.g., B or higher) or a reasonable subsequent condition (e.g., requiring the employee to remain employed for one year after course completion). Regs. Sec. 1.127-2(i) provides that an employee receiving payments under a qualified EAP must be prepared to provide substantiation such that it is reasonable to believe that the payments or reimbursements made under the program constitute educational assistance.
WCFB? Employer educational reimbursements disallowed as a reimbursement under a qualified EAP may still be excluded from an employees income under Sec. 132(d) as a WCFB. For this provision to apply, however, a course must relate to maintaining or improving skills required by the employees job (rather than meeting the minimum skill level required for the job); further, the education itself must not qualify the individual for a new trade or business. Job-related education may be furnished directly by the employer, either alone or in conjunction with other employers, or through a third party (e.g., an educational institution or seminar organization). Employer payments or reimbursements for job-related educational expenses are excluded from the employees income as a WCFB. The exclusion is available for any form of educational instruction or training that improves or develops the job-related capabilities of the individual and is otherwise deductible as a WCFB.
Exceeding the Cap If more than $5,250 of educational assistance is provided to an employee in a program year and the educational assistance is provided for job-related courses, the cost of educational assistance in excess of the $5,250 income exclusion cap may qualify as a WCFB. If the educational assistance is provided for courses that are not job related (i.e., does not qualify as a WCFB), the proper treatment depends on whether the educational assistance is provided as a cash payment or in-kind. Cash payments (or reimbursements) for educational assistance in excess of the $5,250 cap are taxable employee compensation for Federal income tax withholding, FICA and FUTA purposes, and included as wages on the employees Form W-2. The employer should treat excess assistance as wages when payment to (or on behalf of) the employee exceeds the limit. The employees Federal income tax and FICA should be collected from the employee, or paid by the employer and reflected in a grossed-up wage computation. Regs. Sec. 1.61-21(b)(3) states that when a Code provision establishes a limited tax-free exclusion based on the employers cost (i.e., Sec. 127 provides an income exclusion for educational assistance, the cost of which does not exceed $5,250), the fair market value (FMV) of the fringe benefit attributable to any excess cost is taxable employee compensation. Thus, if in-kind educational assistance is provided, the FMV of the cost of educational assistance in excess of the $5,250 cap is taxable compensation for income tax withholding, FICA and FUTA purposes and included as wages on the employees Form W-2. Regs. Sec. 1.61-21(b)(3) clearly applies to on-site education provided directly by an employer. It also appears to apply to education provided at a school, but paid for directly by an employer.
Qualified EAPs and Cafeteria Plans A cafeteria plan allows employees to choose between a benefit (e.g., medical, dental or dependent care assistance) or cash. However, a qualified EAP cannot offer a choice between educational assistance and taxable remuneration. Accordingly, qualified EAPs are barred from inclusion in a cafeteria plan, under Sec. 127(b)(4) and Regs. Sec. 1.127-2(c)(2).
Conclusion Hastings direct payment of Sallys tuition to Private College qualifies as educational assistance under the qualified EAP, even though it is not directly related to her current job, and, in fact, qualifies her for a new trade or business. (This education is not a WCFB.) The portion of the $6,000 payment not exceeding the $5,250 cap is exempt compensation for income tax withholding, FICA and FUTA purposes, and is not included as wages on Sallys Form W-2. The $750 ($6,000 $5,250) excess cost is taxable employee compensation. Hastings withholds Federal income tax and FICA and pays FUTA on the excess amount, and reports it as taxable wages on Sallys Form W-2. Hastings direct payment of Sallys payroll seminar is business related, and so qualifies as a WCFB. Hastings treats this cost as exempt for Federal income tax withholding, FICA and FUTA purposes, and does not report this amount as taxable wages on Sallys Form W-2. Jeffs attendance at the local computer programming seminar qualifies as educational assistance, even though it is not directly related to his current job and may help qualify him for a new trade or business. A similar result occurs for the reimbursement of Jessicas seminar registration and materials costs. All these amounts are clearly education assistance; their reimbursement qualifies for income exclusion under the qualified EAP. These amounts are deductible business expenses, are exempt compensation for Federal income tax withholding, FICA and FUTA purposes and are not included as wages on the employees Forms W-2. Although some of these amounts might also qualify as a deductible/tax-free WCFB, the qualified EAP rules apply first. Such amounts must be initially applied as educational assistance under the qualified EAP to the extent they do not exceed the $5,250 cap. However, amounts qualifying for WCFB treatment are not counted in determining whether other educational assistance received during the year exceeds the $5,250 cap. Although Stans reimbursement is for graduate-level courses, it qualifies for the Sec. 127 educational assistance exclusion for 2003. The $2,000 will be treated as exempt compensation for Federal income tax withholding, FICA and FUTA purposes, and is not included as wages on Stans Form W-2. Jessicas travel expenses to attend the Florida seminar do not qualify as educational assistance under Sec. 127. However, they may be deductible as either a WCFB or as an ordinary and necessary business travel expense. If so, they are exempt from Federal income tax withholding, FICA and FUTA, and are not included as wages on Jessicas Form W-2. |
