Employer's Payment of Educational Expenses of Employee

by Peter Soh, CPA

An employee must include in income the value of educational benefits provided by an employer unless the cost of such benefits qualify as a working condition fringe or is paid for under an accountable plan.

WORKING CONDITION FRINGES

Any employer-provided educational expenses that an employer pays on behalf of an employee are excludable from the employee's income as a working condition fringe (Reg. ¤1.132-1(f)) to the extent that:

1. if the employee paid the benefit, the amount paid would have been deductible under IRC ¤162 or IRC ¤167; and
2. the employee's deduction in 1) would have been allowable with respect to the employee's trade or business of being an employee of the employer pursuant to Reg. 1.132-5(a)(2).

For an educational expense to be deductible under IRC ¤162, the expenses must qualify under Reg. ¤1.162-5. Pursuant to Reg. ¤1.162-5, expenditures made by an individual for education which are not expenditures which meet the minimum educational requirements for qualification in an employee's employment or other trade or business, or expenditures which are not part of a program of study being pursued which will lead to qualifying the employee for a new trade or business, are deductible as ordinary and necessary business expenses if the education 1) maintains or improves skills required by the individual in his employment or other trade or business, or 2) meets certain expressed requirements of the individual's employer, or the requirements of applicable law or regulations, imposed as a condition to the retention by the individual of an established employment relationship, status or rate of compensation. Reg. ¤1.162-5(a).

If an employer reports education expenses that are working condition fringes as includable income on an employee's Form W-2 (e.g., where the employer did not know that the benefit was a working condition fringe), then the employee must report the excludable amount of education expenses in income. The employee may correct this by deducting the amount of the working condition fringe in computing adjusted gross income ("AGI") (i.e., above the line) and showing this on Form 2106. Notice 89-33, 1989-1 CB 674.

EDUCATION EXPENSES PAID UNDER A REIMBURSEMENT ARRANGEMENT

If an employer's payment of an employee's education expenses is a payment under a reimbursement arrangement that is an "accountable plan," the payment is excludable from the employee's gross income. The reimbursement arrangement will qualify as an accountable plan where 1) the reimbursed expenses are ordinary and necessary expenses that are paid or incurred by the employee in connection with his performance of services as an employee solely for the benefit of the employer; 2) the reimbursement arrangement requires each expense to be substantiated; 3) if both wages and reimbursement are combined in a single payment, the reimbursement must be identified either by specifically identifying the amount or by making a separate payment and 4) a total amount of reimbursement to the employee does not exceed the amount of the expenses. Reg. ¤¤1.62-2(c), (d), (e) and (f).

If the payment is made under an arrangement that is a "nonaccountable plan", the payment is includable in the employee's gross income and may be deductible as a miscellaneous itemized deduction subject to the 2% of AGI limitation. Reg. ¤1.62-2(c)(5).

DEDUCTIBILITY BY EMPLOYER

Both the employer-provided educational expenses working condition fringe and the employer-paid educational expenses under a reimbursement arrangement (whether under an "accountable plan" or "nonaccountable plan"), are fully deductible if they are ordinary and necessary reasonable expenses of carrying on a trade or business. Reg. ¤1.162-7(a).

IRC ¤127 TERMINATION

Prior to 1/1/95, IRC ¤127 provided that employees were able to exclude from gross income $5,250 for reimbursement of educational expenses if the amount was paid to or on behalf of the employee for educational assistance under a qualified educational assistance program of the employer.

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