By Jeremiah D. Wood
As you have probably heard, student loan debt is a big issue. According to federal statistics, 69 percent of college students in the Class of 2019 took out student loans, and they graduated with an average debt of $29,900 per student. Additionally, approximately 14 percent of these students’ parents took out loans to assist their children attend college. Overall, there is more than $1.71 trillion in student loan debt in the United States, and this is spread out over approximately 44.7 million borrowers. So, what are some methods an employer can use to assist its employees and attract new employees related to student loan debt? This article will discuss two options that the IRS allows employers to use to assist with and encourage the repayment of student loan debt.
Back in March of 2020, which feels so long ago yet somehow as if it were yesterday too, the CARES Act was passed to respond to the COVID-19 Pandemic. In this massive piece of legislation was a provision allowing employers to pay off student loans for their employees on a tax-free basis for the employee. The amounts paid by the employer on the student loans are tax-free to the employees whether the employer reimburses the individual employee directly, pays the educational institution directly, or pays the financial institution that maintains the student loan.
This new benefit must be part of an education assistance program, which is allowed pursuant to Internal Revenue Code (IRC) section 127. Prior to the CARES Act the benefit of an educational assistance program was limited to the employer paying for either (1) tuition, fees, books, supplies and equipment, incurred by or on behalf of an employee for education or (2) actually providing the education to an employee (i.e., on-site classes). Thus, the addition of paying off student loans is significant.
The CARES Act only allowed the payment of employee’s student loans (both principal and interest) to qualify for an educational assistance program if it was paid between the passage of the CARES Act (i.e., March 27, 2020) and December 31, 2020. However, this provision was so popular that the Consolidated Appropriation Act 2021 extended this period to December 31, 2025.
The dollar amount of the repayment of the student loan made pursuant to an education assistance program is limited to $5,250 per year, which is the normal limit for benefits provided pursuant to IRC section 127. Thus, if there were already benefits being provided through an educational assistance program, the total amount eligible for exclusion from an employee’s income is $5,250. There has been proposed legislation that would increase this limit, which has been the same since 1986, but nothing has been made law.
The employer can pay off the principal and interest on the employee’s student loan, and the amount paid on behalf of the employee is excluded for income tax purposes and for payroll tax purposes. Thus, there is an additional tax benefit for employers as well because they save on payroll taxes while still getting a deduction for the benefit provided. One thing an employer should keep in mind though is that the employee may be able to deduct the interest she/he is paying on their student loan, so the employer should consider applying all of its payments towards principal.
In order for an employer to offer this benefit, there are a few requirements that must be met. These are generally:
- There must be a written plan document that establishes the requirements of the program.
- The program can only be for employees, which includes present employees, retired, disabled or laid-off employees or employees on leave. This obviously excludes employee's children and/or spouses.
- The program cannot only be available to those employees who are deemed to be highly compensated employees (making $130,000 or more in 2020) or the spouses or dependents of such employees who are themselves employees. This is similar to the nondiscrimination requirements that are applicable to many benefits provided to employees pursuant to the IRC.
- Generally, the program cannot provide more than 5 percent of the amount paid or incurred by the employer for educational assistance during a limitation year (i.e., 12- month period) to certain owners/shareholders of the employer offering the program.
- The program cannot allow the employees to choose between taxable compensation or the educational assistance under the program. So, they only get the tax-free benefit of educational assistance or nothing.
- The program cannot be part of a cafeteria plan. Therefore, it must be a stand-alone fringe benefit.
- The sponsoring employer must provide the eligible employees a notice regarding the program's terms and availability.
The tax-free reimbursement of educational expenses and student loans are nice fringe benefits, but if this does not appeal to an employer, then it could consider an alternative with similar benefits. Way back in the summer of 2018, the IRS issued a private letter ruling to Abbott Laboratories that authorized Abbott to make an employer contribution (similar to its matching contribution but not technically a match) to its 401(k) Plan on behalf of those employees who were paying off their student loans but not making a 401(k) deferral into the 401(k) Plan. This “matching” of student loan repayments is a great way for an employer to encourage and reward those employees who may be starting out in the workforce with large student loans and thus cannot afford to make both 401(k) deferrals and student loan payments. This employer contribution will help these young employees save for their retirement early, which has significant benefits in itself.
In 2019, the IRS signaled that it was going to turn the Abbott private letter ruling into a revenue ruling, which is significant because only the taxpayer who receives the private letter ruling may technically rely on the issues discussed therein whereas a revenue ruling would provide guidance for all taxpayers to rely on. Also, the IRS indicated that the revenue ruling would be more expansive than the specific arrangement discussed in the Abbott private letter ruling.
As recently as March 4 2021, at a virtual tax law conference hosted by the Federal Bar Association, Stephen Tackney, who is the deputy associate chief counsel of the IRS Office of Chief Counsel for employee benefits, said that the IRS is still looking into this issue — specifically on how the discrimination rules would work. Unfortunately, similar to many other things, the COVID-19 Pandemic has delayed the IRS working on this issue. In the meantime, an employer could apply to the IRS, similar to Abbott, for a private letter ruling for its own student loan “matching” program within its 401(k) Plan.
The education assistance program discussed above is a tax-free manner of paying off student loans whereas the “matching” of student loan repayments would be a tax-deferred manner of rewarding the repayment of student loans. Thus, there are obviously different motivations at play here. It is worth noting that there is nothing limiting an employer from providing both of these benefits at the same time.
If you have any questions about either of these options, please contact one our Employee Benefits attorneys.
Jeremiah D. Wood practices in the firm’s Employee Benefits and Executive Compensation Practice Group. His practice includes experience in the design, implementation, administration and termination of tax-qualified retirement plans (including traditional pension plans, cash balance plans, profit-sharing plans, 401(k) plans, and ESOPs), 403(b) plans, nonqualified deferred compensation plans (including 457(b) and 457(f) plans and deferral compensation arrangements for executives) and health and welfare plans.
Disclaimer: The information included here is provided for general informational purposes only and should not be a substitute for legal advice nor is it intended to be a substitute for legal counsel. For more information or if you have further questions, please contact one of our Attorneys.