One of Congress’s economic responses to the COVID-19 crisis is a temporary tax incentive for companies to help employees pay their student debt.
Until the end of 2020, employers can contribute up to $5,250 toward an employee’s student loan balance and the payment will be free from payroll and income tax under a provision in the Coronavirus Aid, Relief, and Economic Security (CARES) Act, P.L. 116-136. A separate provision in the CARES Act temporarily pauses the monthly payments due on federally held student loans through Sept. 30, with 0% interest.
Fewer than 10% of companies currently offer student loan repayment assistance. According to one 2019 survey, more than 60% of employed adults in the United States with student loans would consider switching companies to gain a student loan payment benefit.
Will employers take advantage of this incentive to provide student loan assistance? Given pandemic-related cutbacks and business challenges, many companies may hesitate to create a new employee benefit, except perhaps in fields where intense job market competition exists.
Helping employees pay their student loans
Traditionally, an employer’s student loan contributions are subject to payroll taxes and are taxable income to the employee. The CARES Act modifies this tax treatment for payments made after March 27, 2020, and on or before Dec. 31, 2020. During this time span, employees can receive up to $5,250 to pay their student debt and exclude it from gross income (CARES Act, §2206).
Essentially, the CARES Act expands the scope of Sec. 127, which addresses employer-paid tuition benefits, to cover student loan payments. The $5,250 that employees are permitted to receive tax-free for their education under Sec. 127 can also be used in 2020 for student loan repayment. The funds must be applied to the employee’s own student debt, not the debt of the employee’s spouse or dependents.
Specifically, the act amends Sec. 127(c)(1)’s definition of “educational assistance” that can be received tax-free from an employer to include:
in the case of payments made before January 1, 2021, the payment by an employer, whether paid to the employee or to a lender, of principal or interest on any qualified education loan (as defined in section 221(d)(1)) incurred by the employee for education of the employee.
Structuring a student loan payment program
Employers should keep in mind that paying an employee’s student loan interest might inadvertently reduce the employee’s student loan interest deduction. Most student loan borrowers can deduct up to $2,500 in interest, but the CARES Act denies them the double tax benefit of being able to deduct interest that is excluded from their income because it was paid by their employer (see Sec. 221(e)(1), as amended by the CARES Act).
Employers planning to make tax-free student loan contributions in 2020 should be sure to have in place a written educational assistance program (EAP) that satisfies the requirements of Sec. 127. Employers with existing EAPs may need to amend their plan to cover student loan repayment. Among other things, an EAP:
Must be set forth in a separate written plan;
Must not discriminate in favor of highly compensated employees; and
Must be sufficiently communicated to employees.
One other crucial restriction is that an EAP “must not provide eligible employees with a choice between educational assistance and other remuneration includible in gross income,” in the words of Sec. 127(b)(4). In determining whether this requirement is met, the business practices of the employer (as well as the written program) will be taken into account (Regs. Sec. 1.127-2(c)(2)).
In the CARES Act, Congress recognized that millions of Americans struggle under the weight of enormous student debt and sought to encourage employers to help address the problem by creating employment benefit programs. The tax break is currently set to expire after 2020, unless lawmakers extend it.