Section 2206 of the CARES Act allowed an exclusion of up to $5,250 from an employee’s gross income, if an employer paid principal or interest on an employee’s “Qualified Education Loan”.
Section 2206 of the CARES Act was only designed to be in effect for calendar year 2020. However, The Consolidated Appropriations Act, 2021 (the “CAA”) extends this provision of the law through December 31, 2025.
This provision of the CAA is in Section 120 of Division EE, called “The Taxpayer Certainty and Disaster Tax Relief Act of 2020”.
It does not appear that during 2020, many employers decided to provide student loan forgiveness as an employee benefit. Given the pandemic, that is certainly understandable. However, going forward, it might be something that employers might find more attractive as a recruiting or retention tool. Thus, the following is a brief refresher on this benefit.
Code Section 127 – Education Assistance Programs
Internal Revenue Code (the “Code”) Section 127 has for a very long time, provided an exclusion from an employee’s gross income for reimbursement provided to the employee under an employer’s “educational assistance program”. The maximum amount of tax-free reimbursement is $5,250 per calendar year.
The employee’s education under the program may be reimbursed without regard to whether it relates to the employee’s employment. However, the educational expenses cannot pertain to a sport, game or hobby.
The CARES Act
Section 2206 of the CARES Act amended Code Section 127 to allow an employer to pay for all or part of an employee’s “Qualified Education Loan” as a tax-free benefit, provided that benefit is provided as part of an employer’s education assistance program.
An important point to note is that the employee would not have had to incur the educational expenses while that person was an employee of the employer.
For example, an existing employee with student loan debts that were incurred prior to be being hired, can have that debt forgiven under the plan. Likewise, a newly hired employee with pre-existing student loan debt can also have that debt forgiven under the plan.
Code Section 127 – Employer Plan Requirements
Under Code Section 127, the employer must establish a written plan and communicate the terms of that plan to eligible employees. In addition, the Plan must satisfy the following requirements:
- The terms of the Plan cannot discriminate in favor of highly compensated employees (“HCEs”).
- For this purpose, Code Section 414(q) is referenced. In 2021, an employee is an HCE if he or she had compensation of more than $130,000 in 2020. 5% owners of businesses are also considered to be HCEs.
- Collectively bargained employees must be considered in determining nondiscrimination eligibility requirements, unless educational assistance benefits were the subject of good faith bargaining.
- Controlled group rules apply for testing nondiscrimination.
- The calendar year $5,250 maximum exclusion for loan forgiveness must be combined with any other educational assistance that is provided to the employee under the employer’s Code Section 127 plan for that calendar year.
- The plan cannot permit an employee to choose between taxable compensation and benefits and the educational assistance. Thus, an employee cannot elect salary reduction as a means of participating in the Section 127 plan. Simply put, the benefits under the plan have to be employer paid benefits.
Qualified Education Loans
The rules that define what will qualify as a “Qualified Education Loan” are somewhat complex. The IRS advises taxpayers to review Chapter 4 of IRS Publication 970.
However, in general, the loan had to be incurred for the employee’s costs of attendance (i) in pursuit of a degree, certificate, or other program that would lead to a “recognized educational credential”, and (ii) while carrying a course load at least one-half (1/2) of the normal course load for that particular course of study.
Loans from the government or a financial institution are fine. Loans from family members don’t qualify. Loans from tax-qualified employer retirement plans (e.g. 401(k) Plans) don’t qualify.
Attendance at an “eligible education institution” is required. In general, this will include all colleges, universities, vocational schools and other post-secondary institutions that are eligible to participate in the federal student aid program.
Costs of attendance at the eligible education institution include tuition and fees, books, supplies, transportation, miscellaneous personal expenses, room and board and various other costs.