What Is an Employer Educational Assistance Program?

An employer educational assistance program is a workplace benefit where a company pays for certain educational costs for its employees. These arrangements allow employees to advance their skills with financial support, while employers cultivate a more knowledgeable workforce and attract talent. The structure of these programs is governed by specific tax code provisions to ensure they deliver their intended advantages.

Employee Tax Benefits and Covered Expenses

The main advantage for an employee participating in a qualified educational assistance program is a tax benefit. Under Section 127 of the Internal Revenue Code, an employee can receive up to $5,250 in educational benefits from their employer each calendar year without that money being counted as taxable income. This means the assistance is not subject to federal income tax, Social Security, or Medicare taxes. The employer also benefits by being able to deduct these payments as a business expense.

Any assistance an employee receives beyond the $5,250 annual limit is considered taxable compensation. This excess amount will be included in the employee’s wages reported in Box 1 of their Form W-2, and all applicable employment taxes will be withheld. The $5,250 limit is applied on a “use it or lose it” basis for each calendar year, meaning any unused portion of the exclusion does not carry over to the next year.

Covered costs include tuition, mandatory fees, books, supplies, and required equipment for a course of study. The education does not need to be directly related to the employee’s current job role, and the benefit can apply to both undergraduate and graduate-level courses.

Certain costs are specifically excluded from being covered by a Section 127 plan. These non-qualifying expenses include payments for meals, lodging, or transportation. Also excluded are tools or supplies that an employee can keep after the course is finished, with the exception of textbooks. Courses related to sports, games, or hobbies are not covered unless they are part of a degree program or have a reasonable relationship to the employer’s business.

This benefit also allows for the payment of qualified student loans. As part of the Consolidated Appropriations Act, employers can use program funds to make principal or interest payments on an employee’s existing student loans. This provision, which is set to expire at the end of 2025 unless extended by new legislation, applies to payments made directly to the employee or to their loan servicer. The funds used for loan repayment are combined with any other educational assistance received during the year and are subject to the same $5,250 tax-free limit.

Requirements for a Qualified Program

For employees to receive tax-free educational benefits, the employer’s program must meet several requirements outlined in the tax code. A primary requirement is that the employer must establish a separate, written plan document. This document details the terms of the program, eligibility rules, and the benefits provided, creating a formal framework.

A requirement is that the program cannot discriminate in favor of highly compensated employees (HCEs). An HCE is defined by an income threshold or ownership stake in the company. This nondiscrimination rule ensures that the benefits are available to a broad range of employees, not just executives or top earners.

Employers are obligated to provide reasonable notice of the program’s availability and terms to all eligible employees. This ensures that all individuals who could potentially benefit from the program are aware of its existence and understand how to participate.

The plan cannot offer employees a choice between receiving educational assistance and receiving other forms of taxable income, such as cash or a bonus. The benefit must be offered exclusively as educational assistance. This rule prevents the program from becoming a disguised deferred compensation plan.

There is also a specific limitation concerning business owners. No more than 5% of the total benefits paid out by the program during a calendar year can be provided to individuals who are shareholders or owners of more than 5% of the company’s stock or capital. This rule prevents small business owners from creating a plan primarily for their own benefit.

Interaction with Other Education Tax Credits

Employees who receive tax-free educational assistance must be aware of how this benefit affects their ability to claim other education-related tax benefits. A “no double-dipping” rule applies, meaning an employee cannot use the same educational expenses paid for with tax-free employer assistance to also claim a tax credit. Because the employer-provided funds are already excluded from income, claiming a credit on those same dollars would be a duplicative tax benefit.

For example, if a student’s total qualified education expenses for the year are $7,000 and their employer provides $5,250 in tax-free assistance, only the remaining $1,750 can be considered for other tax credits. The employee paid this portion out-of-pocket, making it potentially eligible for the American Opportunity Tax Credit (AOTC) or Lifetime Learning Credit (LLC), assuming all other requirements for those credits are met.

The AOTC is a credit of up to $2,500 per eligible student for the first four years of higher education, while the LLC offers a credit of up to $2,000 per tax return for a broader range of courses. When preparing their tax return, an employee would use Form 8863, “Education Credits (American Opportunity and Lifetime Learning Credits),” to calculate any potential credit based on their out-of-pocket expenses.