Imagine a nonprofit employee who handles finances for the organization. She graduated with a degree in business administration, and now wants to develop her skills by taking additional finance courses. May the nonprofit help ease the accompanying financial burden through pre-tax educational assistance? And to what extent?
The short two-part answer is (a) up to $5,250, with certain program conditions, or (b) to an unlimited monetary amount, so long as the educational program will develop the employee’s skills within her current role, and not prepare her for a different profession. Notably, an employer may offer both options to its employees; they are not mutually exclusive, but they involve distinctive differences. Also, thanks to recent federal legislation, student loan repayments are eligible for the $5250 benefit – at least through December 31, 2025.
Annual Pre-Tax Benefit of $5,250 – Come and Get It!
Under Section 127 of the Internal Revenue Code, nonprofit employers may offer up to $5,250 annually, per employee, in tax-free educational assistance benefits.
Covered educational opportunities generally include instruction that develops an employee’s capabilities, either at undergraduate or graduate levels. For this pre-tax benefit, the nonprofit employer must develop a written, qualified educational assistance program, available exclusively to employees. It may not cover education for the employees’ spouses or dependents.
A nonprofit employer’s payments for employees’ educational expenses do not have to be solely for tuition. Tax-free educational assistance benefits may include the following: payment for tuition, school fees and similar expenses, books, supplies, and equipment. Now student loan repayments are included too for debt incurred before employment, so long as they otherwise fit with the already established parameters for this annual employee benefit.
Note, however, that this educational assistance benefit does not include payments for the following items:
a. meals, lodging, or transportation;
b. tools or supplies (other than textbooks) that are kept after completing the course of instruction; and
c. courses involving sports, games, or hobbies unless they have a reasonable relationship to the business of an employer, or are required as part of a degree program.
Additionally, the written plan must meet the following conditions:
a. it is not discriminatory (that is, set up to favor highly compensated employees);
b. not more than 5% of the program’s benefits are for shareholders or owners (inapplicable for nonprofits);
c. the benefit is not available to employees who earn more than $125,000 per year;
d. it does not offer cash or other taxable benefits in lieu of the educational benefits; and
e. reasonable notice of the program is given to eligible employees.
In the example above, the employee handling finances for her nonprofit employer may receive this tax benefit for any educational program up to the $5,250 pre-tax annual benefit limit, provided that the above plan elements are satisfied.
Consider too that if an employer pays an employee more than $5,250 annually in educational assistance benefits under this Section 127 arrangement, then the employee may owe income tax on the amount over $5,250. An employer thus should include any amount over and above the $5,250 as wages on the employee’s Form W-2.
The Section 127 tax-benefit provides a great perk for a nonprofit’s employees, minimizes employment-related taxes for the employer, and is an effective way to show tangible support to employees seeking to grow in their professional role. From a nonprofit’s budgeting perspective, though, it may become important to ascertain how many employees will take advantage of this benefit, so that the nonprofit may plan accordingly for the resulting financial impact. The details will matter too for optimal legal compliance, such as further addressed in the Internal Revenue Service’s FAQs.
Unlimited Benefit - Working Condition Fringe
Section 162 of the Internal Revenue Code provides another employer option for providing pre-tax educational assistance, without any monetary cap: the working condition fringe benefit. This benefit provides employers perhaps an easier educational assistance program to implement and greater flexibility among employees, particularly since neither a written educational assistance plan nor the salary nondiscrimination provision is required. On the other hand, employees face more limitations in available education opportunities through this employee benefit.
In a nutshell, the working condition fringe benefit permits a deduction for job-related education expenses, provided that one of the following criteria is met:
a. the education must be required by the employer or by law for the employee to keep his or her present salary, status, or job; or
b. the education must maintain or improve skills needed in the employee’s job (and not qualify the employee for a new trade or business).
Even if the education meets one or both of the above two requirements, the expense will not qualify for the working condition fringe benefit if the education is needed to meet the minimum educational requirements of an employee’s present trade or business or if it is part of a program of study that will lead to qualifying for a new trade or business.
In the example above, consider if the employee wanted to take finance classes, perhaps part of an MBA program, so that she could better handle her employer’s finances. The finance classes likely would qualify under Section 162, but it may be questionable whether the broader degree coursework would qualify as well. As another example, HR certification courses taken by an employee working in a nonprofit’s human resources department likely would qualify under Section 162, but an employee’s general classes toward a graduate degree would not. In both cases, the Section 127 benefit may be a more attractive option (albeit with maximum dollar limitations).
Offering Either Pre-Tax Benefit, or Both?
Whether a nonprofit should offer Section 127 or Section 162 educational benefits, or both. all depends on the employer, its desire to offer such employment perks, its financial means to do so (which may be significant), and its capability to handle the accompanying payroll responsibilities. Staying legally compliant throughout is key for both the employer’s and its employees’ well-being. Now that’s educational!
