Our US readers have no doubt noticed that the political discourse over the past few weeks has been dominated by the subject of tax cuts. This past week, President Obama and the Congressional leadership of the Republican party hammered out a potential compromise framework that would allow for the extension of lower marginal Federal income tax rates for all income levels; cuts that were originally enacted by President George W. Bush. Because these past tax-cuts were passed using a special legislative procedural gambit known as “Reconciliation” (some of you might recall this one from the health care overhaul process early in the year), they automatically expire after a set time unless enacted into permanent law through ordinary legislative means.
Regardless of your political leanings – and your opinions about these tax cuts, buried in this discussion is something that everyone with responsibility for L&D should care about. A somewhat obscure section of the IRS tax code, Section 127, is also set to expire at the end of this year.
What is IRS Section 127?
Section 127 allows an employee to receive up to $5,250 per year pre-tax, for both undergraduate and graduate degree education. The education is not required to be job-related. This shelter is meant to encourage ongoing employee development and to help both individuals and organization maintain competitiveness. For example, in 2007 almost half of Section 127 beneficiaries were graduate students, and 45 percent were majoring in STEM subjects (science, technology, engineering, and math and business management).
Of course, employers are not required to provide this assistance to their employees; but it is a good idea.
In order for Section 127 to apply to an education benefit plan, the following conditions must be met:
it must be established as a separate plan;
it must be provided for the "exclusive benefit of employees";
it must not discriminate in favor of the highly compensated (in other words – this is not meant to be a special option just for certain segments of the population); and
it must provide educational benefits (including tuition and fees, books, supplies and equipment);
it must not include an offer of alternative benefits to education (the employee can’t opt out and receive something else instead).
Section 127 programs apply only to current and former employees (and certain self-employed individuals). Spouses or dependents of employees are not eligible.
Section 127 money can be spent on tuition, books, supplies, and equipment necessary for class. It does not cover tools or supplies which employee may keep after the course is completed (meaning it is not meant to be used as way to buy a computer for instance); education involving sports, games, hobbies (unless job-related), meals, lodging, or transportation.
What is happening?
Section 127 was originally established way back in 1978 as a five-year provision to give officials time to study the benefits of the approach. When it first expired at the end of 1983, a series of extensions were passed. Section 127 has been extended eight times, most recently in 2001.
Section 127 is a generally popular employer-provided benefit that enjoys bipartisan support among lawmakers as evidenced in past support of such measures. The bill also has widespread support among employers, education and labor groups. However, this provision is now caught up in political debate over the Federal budget deficit and streamlining the tax code.
What’s being done?
Reps. Earl Pomeroy, D-N.D., and Sam Johnson, R-Texas, have introduced the Employee Educational Assistance Act of 2010 (H.R. 5600) to make Section 127 permanent. And Sen. Charles Grassley, R-Iowa, has introduced a broader tax bill (S. 2851) that would lock in several pro-education tax provisions, including Section 127.
Extending Section 127 is also part of the compromise reached by President Obama and the Republican party. Of course, whether or not that compromise – or some other related tax bill is still uncertain.
The Coalition to Preserve Employer Provided Education Assistance (www.cpepea.com) is a broad-based collection of groups representing business, labor and education, involving both SHRM and ASTD, that is advocating for a permanent extension of Section 127.
What should you do?
If Section 127 is important to you or your organization, find ways to influence the current public policy debate.
Just in case this provision is not renewed, make contingency plans.
While not optimal, there are other provisions in the U.S. tax code that may allow employees to take deductions for courses that are related to their employment, including:
Section 132(d): Working Condition Fringe Benefit
Allows for related expenses to be deducted from income, as long as they are:
directly related to the job the person is presently performing and help to maintain or improve skills needed in that position; OR
required by the employer or by law as a condition of employment.
The training in question cannot be for preparing for a new role or trade, only maintaining or improving the current one.
Working condition fringe benefits include property or services that, if the employee had paid for, he or she could have deducted the cost as a business expense on his or her individual income tax return. Therefore, if the cost of an item is deductible by an employee as a business expense, it may be excludable from the employee’s wages as a working condition fringe benefit if provided by the employer.
It is not required that the employer have a written plan or dollar limitations, and the employer may discriminate in favor of highly-compensated employees.
What actually constitutes educational costs that are both related to the employer’s business and meet all of the applicable Treasury Regulations and, consequently, qualify as a “working condition fringe” benefit is not well defined and has been the subject of several court cases. So far court precedent has held that education expenses that:
allow the employee to meet the minimum educational requirements for qualification in their current job (remedial training);
qualify the employee for a promotion or salary increase; or
prepare the employee for a wholly different position in a new trade or business
do not qualify as a working condition fringe benefit. What remains are just those activities which simply make the employee better at their current job.
If the education expenses do not qualify as a working condition fringe benefit, then (generally) the expense is includable in the employees taxable income and not deductible by the employer.
Other alternatives for certain types of employers:
IRC 117(b) – Qualified Scholarships
IRC 117(d) – Qualified Tuition Reductions
Other alternatives for which individual employees may qualify on their own:
Hope and Lifetime Learning Credits
Tuition and Fees Deduction
Student Loan Interest Deduction
For more info:
Publication 970 (2009), Tax Benefits for Education
Taxable Fringe Benefit Guide
Coalition to Preserve Employer Provided Education Assistance
Many US States also offer assistance programs and/or tax-breaks for job-related education expenses and for workforce “re-skilling.” Check with each respective state for more information.
I should end with one caveat. We at Bersin & Associates are not tax professionals; so above all else, seek professional guidance before making any decisions.
Question: How many of you out there are either offering Section 127-based assistance to your employees, or take advantage of such yourselves? Post your answers in the comments.
Questions and comments welcome.