Question: How did the CARES Act and CAA modify and expand upon the §127 tax-free qualified educational assistance program benefits available to employers?
Short Answer: Employers can now provide up to $5,250 in annual student loan repayment assistance benefits to employees on a tax-free basis through 2025.
General Rule: Section 127 Educational Assistance Program
Employers may provide up to $5,250 annually in tax-free compensation to employees under a qualified educational assistance program. Such programs must be maintained pursuant to a separate written plan document, and the employer must provide reasonable notification of the availability and terms of the program to all eligible employees.
Qualified educational assistance programs are subject to nondiscrimination rules to ensure the program does not discriminate in favor of highly compensated employees.
The main advantage of a §127 educational assistance program (as opposed working condition fringe educational benefits under §132) is that the educational expenses covered by the program do not need to be work-related.
However, prior to the CARES Act and the Consolidated Appropriations Act, 2021 (CAA) modifications, student loan repayment assistance did not qualify as an eligible tax-free benefit under §127. Prior eligible expenses included the cost of books, equipment, fees, supplies, and tuition.
New Benefit Available Through 2025: Tax-Free Student Loan Repayment Assistance
The CARES Act initially provided that employers could pay for or reimburse up to $5,250 of an employee’s student loans on a tax-free basis from March 27, 2020 (the date of enactment) through the end of 2020 under a §127 educational assistance program. The CAA extended the availability of this tax-free student loan repayment assistance option for employers through the end of 2025.
The end result is that tax-free educational assistance benefits made after March 27, 2020 and before January 1, 2026 may include payments of principal or interest on any “qualified education loan” incurred by the employee for the education of the employee. Employers may make the payment to the employee or directly to the lender.
The $5,250 annual maximum per employee applies for all §127 payments made by an employer under a qualified educational assistance program. This includes the aggregate of any of the previously available forms of benefits (books, equipment, fees, supplies, tuition) combined with any student loan repayment assistance. Educational assistance amounts provided by employers in excess of $5,250 per year must be included in the employee’s taxable income.
Definition: Qualified Education Loan
Tax-free educational assistance under the CARES Act and CAA through 2025 is available for an employee’s “qualified education loan.”
A “qualified education loan” is a loan taken out by the employee to pay for the employee’s “qualified education expenses” within a “reasonable period of time” before or after taking out the loan for education provided during an “academic period” for an “eligible student” to attend an “eligible educational institution.”
Qualified Education Expenses:
These expenses are the total costs of attending an eligible educational institution. They include amounts for the following items:
- Tuition and fees
- Room and board (with limitations)
- Books, supplies, and equipment
- Other necessary expenses (such as transportation)
Reasonable Period of Time:
Qualified educational expenses are treated as paid or incurred within a reasonable period of time before or after the employee takes out the loan if they are paid with the proceeds a federal postsecondary education loan program.
If not paid with the proceeds of that type of loan, the expenses are treated as paid or incurred within a reasonable period of time if both of the following requirements are met:
- The expenses relate to a specific academic period; and
- The loan proceeds are disbursed within a period that begins 90 days before the start of that academic period and ends 90 days after the end of that academic period.
An academic period includes a semester, trimester, quarter, or other period of study (such as a summer school session) as reasonably determined by an educational institution.
An eligible student is a student who was enrolled at least half-time in a program leading to a degree, certificate, or other recognized educational credential. A student was enrolled at least half-time if the student was taking at lest half of the normal full-time workload for the student’s course of study (generally as determined by the educational institution).
Eligible Educational Institution:
An eligible educational institution is generally any accredited public, nonprofit, or proprietary (privately owned profit-making) college, university, vocational school, or other postsecondary educational institution. The institution must also be eligible to participate in a student aid program administered by the U.S. Department of Education—as is the case with virtually all accredited postsecondary institutions.
What the Future May Hold: Room for Educational Assistance Program Improvement Moving Forward
Congress could further expand and improve upon the CARES Act and CAA tax-free student loan repayment assistance provision in three main ways:
- Make the tax-free student loan repayment addition permanent. Employers may be hesitant to add a robust student loan repayment program in the coming years as the sunset of the CAA tax-free extension at the end of 2025 continues to loom nearer.
- Index the limit for inflation. The $5,250 educational assistance program limit under §127 initially dates to 1979. Given the intense increase in educational (including student loan) costs since then, Congress should consider adjusting the limit annually to an educational inflation index.
- Permit employee pre-tax contributions. Educational assistance repayment assistance must be exclusively employer-paid because the program cannot allow employees to choose to receive taxable cash instead of educational assistance. Congress could easily rectify that flaw by adding §127 qualified educational assistance programs to the list of §125 qualified benefits, and thereby utilize the cafeteria plan safe harbor from the doctrine of constructive receipt to facilitate employee pre-tax contributions.
CARES Act Section 2206 [Initial Period from March 27, 2020 – December 31, 2020]:
SEC. 2206. EXCLUSION FOR CERTAIN EMPLOYER PAYMENTS OF STUDENT LOANS.
(a) IN GENERAL.—Paragraph (1) of section 127(c) of the Internal Revenue Code of 1986 is amended by striking ‘‘and’’ at the end of subparagraph (A), by redesignating subparagraph (B) as subparagraph (C), and by inserting after subparagraph (A) the following new subparagraph:
‘‘(B) 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, and’’.
(c) EFFECTIVE DATE.—The amendments made by this section shall apply to payments made after the date of the enactment of this Act.
CAA Division EE §120 [Extension Through 2025]:
SEC. 120. EXCLUSION FOR CERTAIN EMPLOYER PAYMENTS OF STUDENT LOANS.
(a) IN GENERAL.—Section 127(c)(1)(B) is amended
(b) EFFECTIVE DATE.—The amendment made by this section shall apply to payments made after December 31, 2020.
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