Employer-Provided Tuition Reimbursement Can Be Nontaxable
Learn when employer-provided tuition reimbursement is nontaxable. This guide explains the IRS criteria for both the employer's plan and the education itself.
Employer-provided tuition reimbursement programs are a benefit for employees seeking to advance their education and a strategic advantage for employers. This form of compensation allows companies to pay for an employee’s educational costs. The tax implications of this assistance are governed by Internal Revenue Service (IRS) regulations. Depending on how the program is structured, the financial assistance an employee receives can be either a nontaxable benefit or additional taxable income.
Qualifying for Tax-Free Reimbursement Under an EAP
An employer can provide nontaxable educational benefits through a formal Educational Assistance Program (EAP), governed by Internal Revenue Code Section 127. Under a qualified EAP, an employee can receive up to $5,250 per calendar year tax-free. Any assistance exceeding this threshold is generally considered taxable income unless it qualifies under other tax provisions.
The range of expenses that can be paid for tax-free is broad, including tuition, required fees, books, supplies, and equipment. However, the rules exclude payments for meals, lodging, or transportation. Any tools or supplies that the employee is allowed to keep after the course is completed are also not eligible for the tax-free benefit.
A defining feature of an EAP is that the education does not need to be related to the employee’s current job responsibilities. This allows employees to pursue a wide range of educational goals, including both undergraduate and graduate-level degree programs. Courses for sports, games, or hobbies are not covered unless they are part of a degree program.
The tax-free benefit also extends to certain student loan repayments. Under a temporary provision, employers can make payments toward an employee’s qualified student loan principal or interest. These payments are included under the $5,250 annual tax-free limit, and this provision is set to expire at the end of 2025.
Formal Requirements for an Employer’s Plan
For an educational assistance plan to qualify for tax-favored treatment, the employer must adhere to several formal IRS requirements. The primary requirement is that the plan must be a separate, written document outlining its terms and conditions. An informal policy or verbal agreement is not sufficient.
The plan must also be structured to prevent discrimination in favor of highly compensated employees (HCEs). The IRS has specific tests to determine if a plan is discriminatory, and if it is, the tax-free status of the benefits could be lost for the HCEs.
Another requirement involves a limitation on benefits paid to company owners. No more than 5% of the total benefits paid out by the plan during the year can go to individuals who are shareholders or owners of more than 5% of the company’s stock, including their spouses and dependents.
Finally, the employer must provide reasonable notification of the EAP to all eligible employees, and the plan cannot offer a choice between educational assistance and cash.
Substantiation and Tax Reporting
To receive reimbursement under an EAP, an employee must substantiate the educational expenses they have incurred. This means providing the employer with proof of payment for qualifying costs, such as receipts for tuition, invoices for fees, and records of purchase for books and supplies. Some employers also require proof of satisfactory completion of the coursework, such as a transcript.
For amounts that fall under the $5,250 annual limit and meet EAP qualifications, the reimbursement is excluded from the employee’s income. This nontaxable amount will not appear in Box 1, Box 3, or Box 5 of the employee’s Form W-2.
If an employer provides educational assistance that exceeds the $5,250 annual limit, the excess amount is treated as taxable income. The employer is required to include this excess amount in the employee’s wages on Form W-2. This amount will be reflected in Boxes 1, 3, and 5, and is subject to federal income tax withholding, as well as Social Security and Medicare taxes.
Job-Related Education as a Working Condition Benefit
Beyond a formal EAP, tuition reimbursement can also be provided tax-free as a working condition fringe benefit under Internal Revenue Code Section 132. This alternative is relevant when an employer does not have an EAP, or when assistance exceeds the annual $5,250 EAP limit. Unlike an EAP, there is no dollar limit on tax-free benefits provided as a working condition benefit.
The fundamental difference with this provision is that the education must be directly job-related. To qualify, the coursework must maintain or improve the skills the employee needs for their current position. For example, an accountant taking a course on a new tax law would likely meet this requirement.
The IRS sets boundaries on what does not qualify as job-related education. Education that is necessary to meet the minimum educational requirements for an employee’s current job is not eligible. For instance, if a job requires a bachelor’s degree as a minimum qualification, the employer cannot provide tax-free reimbursement for that degree.
Furthermore, education that qualifies the employee for a new trade or business is also excluded. For example, if a paralegal at a law firm attends law school to become a lawyer, this education qualifies them for a new profession and would not be considered a tax-free working condition benefit.