How to Create a Section 127 Program

A Section 127 program, formally known as an educational assistance program under Internal Revenue Code (IRC) Section 127, offers a valuable benefit for both employers and employees. It enables employers to provide financial assistance for educational expenses, which employees can then exclude from their gross income up to a certain limit each year. This tax-advantaged benefit helps employees pursue further education, enhancing their skills and career opportunities. It also serves as a tool for employers to attract and retain talent. Establishing such a program involves careful planning and adherence to specific IRS guidelines to ensure its compliance and effectiveness.

Key Features of a Section 127 Program

To qualify as a Section 127 program, an educational assistance plan must adhere to several fundamental characteristics and requirements set forth by the Internal Revenue Service. A primary feature is the maximum exclusion amount, which allows an employee to exclude up to $5,250 annually from their gross income for qualified educational assistance benefits. This limit applies to amounts paid or expenses incurred by the employer during a calendar year.

Qualified educational expenses under Section 127 generally include tuition, fees, books, supplies, and equipment for both undergraduate and graduate-level courses. Importantly, these courses do not necessarily need to be job-related. However, certain expenses are typically not covered, such as meals, lodging, transportation, or tools and supplies that an employee can keep after completing the course (other than textbooks). Courses primarily involving sports, games, or hobbies are also excluded unless they are part of a degree program or directly relate to the employer’s business.

A temporary provision, enacted by the CARES Act, allows for the exclusion of payments made by an employer on the principal or interest of qualified education loans. This specific benefit is included within the annual $5,250 exclusion limit and applies to payments made after March 27, 2020, and before January 1, 2026.

The program must also satisfy non-discrimination rules, meaning it cannot favor highly compensated employees, officers, shareholders, or self-employed individuals. Furthermore, the program cannot offer employees a choice between receiving educational assistance and other taxable remuneration, such as cash. The plan must be established as a separate written document for the exclusive benefit of its employees.

Crafting Your Written Plan

Creating a comprehensive written plan document is the first step in formalizing your educational assistance program. This document serves as the official blueprint for the program, outlining its structure and operational procedures. Clear and unambiguous language is essential to prevent misunderstandings and ensure compliance with IRS regulations.

The written plan must include a clear statement of purpose, defining the program’s objectives, such as fostering employee development or enhancing specific skill sets. Establishing precise eligibility criteria is also important, specifying which employees can participate (e.g., full-time, part-time, length of service requirements), while adhering to non-discrimination rules. The document should explicitly list the types of educational expenses that the program will cover, aligning with the definition of “qualified educational expenses” under Section 127.

The plan must detail the application and approval process employees need to follow when seeking assistance. This includes requirements for pre-approval, submission of necessary documentation like tuition statements or course schedules, and procedures for submitting proof of completion, such as grades or certificates. Clear reimbursement procedures should be outlined, indicating when and how payments will be made, whether directly to the educational institution or as reimbursement to the employee.

A specific annual dollar limit per employee must be stated, which should not exceed the current Section 127 maximum of $5,250. The plan should also specify its effective start date and, if applicable, its intended duration. Provisions for amending or terminating the plan are also required, outlining the internal processes for making such changes. Once drafted, the plan should undergo internal review and approval by relevant departments, such as management, human resources, and legal counsel, to ensure its accuracy and alignment with organizational goals.

Ongoing Program Management

Ongoing management ensures a Section 127 program’s continued compliance and effectiveness. Once established, communicate the program’s availability and details to all eligible employees via internal memos, employee handbooks, or HR portal sections.

Administration involves managing applications and processing reimbursements according to the written plan. This includes setting up a tracking system to monitor requests, approvals, and payments, ensuring accurate submissions. Promptly process payments and verify expenses align with defined qualified educational costs.

Record-keeping is essential. Employers must maintain detailed records of all educational assistance provided, including documentation of expenses, course completion, and grades. Retain copies of the written plan and any amendments. These records demonstrate compliance during IRS reviews.

Annual compliance checks confirm the program meets all Section 127 requirements. Verify adherence to non-discrimination rules and ensure the $5,250 exclusion amount is not exceeded. Amounts provided are excludable from gross income and not reported on Form W-2. Any assistance exceeding the annual limit becomes taxable income and must be reported. Employers can deduct amounts paid as a business expense.