Tax Free Student Loan Assistance
The CARES Act expanded the scope of Internal Revenue Code (IRC) Section 127—which addresses employer-paid tuition benefits—to include up to $5,250 of tax-free student loan assistance on an annual basis. Initially, the CARES Act expansion of IRC §127 only applied to employer student loan assistance made after March 27, 2020, and before January 1, 2021.
However, on December 21, 2020, the tax-free student loan assistance provision was extended to January 1, 2026, under the 2021 Consolidated Appropriations Act (Act). The passage of this Act provided stability to the student loan assistance program. The provider's five-year extension offers employers and employees an opportunity to receive substantial benefits from this program.
What's in it for the employer?
With the rising amounts of student loan debt and the cost of education on the rise, the average student loan payment will likely follow the same trajectory. Given the scale of the student loan debt in the U.S., an investment in employee student loan assistance may be the competitive advantage employers need to navigate the challenges brought on by the pandemic. While every industry has faced unique business challenges during the pandemic, what they all have in common is the expense of hiring, replacing, and training employees. To successfully navigate and adapt to the new business environment, it's crucial to obtain and retain your organization's best people.
The expansion of IRC §127 provides a monetary benefit to include student loan assistance. Up to $5,250 in aid to each qualified employee will be excluded from payroll taxes and deducted for income tax purposes. For 2021, this would add up to a 7.65 percent payroll tax savings for both the employer and employee (assuming the employee is below the Social Security wage base). The employer would receive an income tax deduction for the payments made.
The federal government has undoubtedly shown compassion to student loan borrowers amid the COVID-19 pandemic. On his first day in office, President Biden issued an executive order asking the U.S. Department of Education to extend pandemic relief for federal student loan borrowers through September 2021, which alleviates monthly loan payments and accrual of interest. The relief is in addition to the tax incentive provided from the expansion of §127.
It's important to note that businesses weren't prevented from providing employee student loan assistance as a compensation function before the CARES Act. From a tax perspective, the difference is the benefit won't be included on the employees' W-2 and thus not subject to income and payroll taxes. However, an employee cannot claim a deduction for the portion of student loan interest expense paid by the employer. In general, most student loan borrowers can deduct up to $2,500 in interest, but this benefit could be limited for some borrowers due to this provision in the CARES Act.
While most would consider this provision to be beneficial for both the employer and employee, this is ultimately a business decision that presents several points to consider:
Until September 30, 2021, employees with federal student loans aren't required to make a student loan payment. Do you want to invest in assistance while the employee is not receiving a bill for their loan?
Not all employees will benefit from student loan assistance. How will your organization handle the inequity in compensation?
Employers should consider the cost and administrative burden of providing this benefit.
How to Set Up an Educational Assistance Program
To develop an educational assistance program (EAP) for tax-free student loan contributions, the employer must create a separate written plan within the requirements of IRC §127. Employers with an EAP already in place will need to modify or amend their current plan should they choose to add the student loan contribution component to their offerings. Consider these items before drafting a plan:
The employer must provide eligible employees with reasonable notification of the availability of this benefit.
The plan can't discriminate toward highly compensated employees.
The employer can issue the payment to the employee or directly to the lender.
The funds must be applied to the employee's student debt, not the employee's spouse or dependents' debt.
The program can't give eligible employees a choice between educational assistance and another form of compensation includible in gross income. This requirement is evaluated based on the employer's business practices and the written program details.
An EAP seems to have similar characteristics to the 401(k), which serves as a mutually beneficial employer benefit to assist with retirement. If so, this may be an attractive solution for employers to help alleviate some of the student loan burdens for employees while giving employers a deduction on their tax returns.