Two recently-enacted stimulus laws, the Coronavirus Aid, Relief, and Economic Security (CARES) Act and the Consolidated Appropriations Act (CAA), provide that an employer may be eligible for tax benefits if the employer makes payments toward its employees’ student loans in certain circumstances. Employers and employees can avoid paying federal payroll taxes on an employee’s student loan payments if those payments are made by an employer under a plan that meets the qualification requirements of CARES and/or CAA.
The CARES Act, signed into law on March 27, 2020, provides a tax exemption for employer payments of an employee’s qualified student loans up to $5,250, provided the payments were made between March 27, 2020, and December 31, 2020. The CAA, signed into law on December 27, 2020, extended that tax benefit to allow employers to provide $5,250 in tax-free payments of their employees’ student loans each year through December 31, 2025.
Neither the Internal Revenue Service (IRS) nor the Department of Labor (DOL) have yet issued much anticipated guidance in response to the newly-created tax benefits for employers’ payments of their employees’ student loans. However, prior IRS regulations regarding employer education assistance plans identified tax benefits for certain types of educational assistance that employers provide to their employees. In general, employers must adhere to all IRS regulations for providing educational assistance to employees to secure these tax benefits. These requirements include:
- A Written Plan. The terms of an employer’s educational assistance plan must be established and set forth in a written plan. This requirement does not preclude an employer from providing an educational assistance plan as part of a more comprehensive employer plan that offers employees a choice of nontaxable benefits. However, employers may not offer cash in lieu of a qualified student loan payment.
- Nondiscrimination Testing. In general, the IRS uses nondiscrimination testing to determine whether and how a specific benefit plan might qualify for a tax exemption based on the manner in which highly compensated employees are treated under the plan. This requirement means that an employer’s educational assistance plan may not provide more than 5% of the amounts paid under the plan to shareholders or owners (or the spouses or dependents of shareholders or owners) who own more than 5% of the outstanding shares, or own more than 5% of the capital or profit interest in the employer. Likewise, the plan may not provide more than 5% of the amounts paid under the plan to highly compensated employees. Highly compensated employees are determined by looking at the employee’s salary for the previous year. For 2021, a highly compensated employee is any employee who made more than $130,000 in salary in 2020.
Employers can require that specified criteria be satisfied for a course of study to qualify for educational assistance under the plan. For example, employers may choose to limit educational assistance to courses of study leading to postgraduate degrees in fields that are related to the employer’s business. However, for purposes of conducting nondiscrimination testing, only those employees who are able to pursue such a course of study are considered to be eligible for educational assistance under the plan.
An employer’s educational assistance plan will not be considered discriminatory merely because the benefits provided are utilized to a greater degree by employees who are subject to the discrimination prohibition than by other employees. Likewise, an educational assistance plan will not be considered discriminatory merely because the plan requires employees to successfully complete the course, attain a particular grade, or satisfy other reasonable conditions, such as requiring an employee to remain employed by the same employer for one year after completing the course.
- Reasonable Notice. Employers must provide reasonable notice of the terms and availability of the plan to all employees who are eligible to participate in the plan.
IRS regulations also provide that employees must “be prepared to provide substantiation to the employer such that it is reasonable to believe that payments or reimbursements made under the plan constitute educational assistance.” 26 CFR § 1.127-2(i). In the case of student loan payments, substantiation will be relatively straightforward. Whether the employer makes the student loan payments directly to the lender or to the employee, there will be a clear record of loan payments made. Nevertheless, employers should notify employees that they should be prepared to provide substantiation that payments or reimbursements made through the plan were used for qualified education expenses. Employers should also consider including a provision in the written plan that requires employees to provide substantiation of payments in order to receive the benefit.
The IRS defines “qualified student loan” as a loan taken out to pay qualified education expenses of attending an eligible educational institution. These expenses include tuition and fees, room and board, books, supplies, and equipment, and other necessary expenses. See IRS Pub. 970, Ch. 11. “Qualified student loan” does not include private loans made between related individuals, and loans from a qualified employer plan (e.g., a loan from a 401(k) plan).
By creating a tax exemption for employer payments of employee student loans, the CARES Act and the CAA provide employers a powerful tool for attracting and retaining employees with post-secondary education and related student loans. Employers with existing educational assistance plans will need to revise their existing plan if they want to include student loan payments. Employers without an educational assistance plan will have to create one if they wish to offer such an employee benefit. Either way, employers looking to offer their employees tax-exempt student loan payments should consult with legal counsel in order to confirm that the plan adheres to all applicable IRS regulations.
For questions regarding this article, please contact your Renning, Lewis & Lacy attorney.