Tax-Efficient Ways to Maintain a Well-Educated Workforce
In an era of intense technological change and global competition (not to mention slow economic growth), employers with a knowledgeable, cutting-edge work- force have an advantage over their competitors.
The recent alliance of Starbucks and Arizona State University to provide subsidized college credit for its employees underscores the increased focus that some employers are placing on an educated workforce. Employees who pursue self-improvement through education tend to exhibit an innovative mindset that leads to greater efficiency and productivity.
From a financial standpoint, the organizational challenge is how to encourage continuing employee education while maintaining some discipline over cost. Tax considerations should not be ignored in determining how to support employee education in a cost-effective manner.
There are two ways employers can provide tax- free educational assistance to their employees. The first is through a formal educational assistance program, and the other is through a “working condition fringe benefit.”
EDUCATIONAL ASSISTANCE PROGRAM
Educational benefits provided to employees under an “educational assistance program” are tax-free up to an annual limit of $5,250. Employers are allowed to deduct the cost of their assistance through a qualified educational assistance program and, in addition to the exclusion from income taxes, the benefits are excluded from employment taxes for both the employer and the employee.
In addition to a potential increase in productivity, this exclusion from income is a significant benefit in its own right, especially for lower-income employees where even a modest tax cost could prevent them from pursuing education.
For employees to obtain the benefit of excluding up to $5,250 in taxable income, the following requirements must be met:
- • There must be a separate written plan;
- • The plan must be only for employees, sole proprietors, or partners;
- • The program cannot favor highly compensated employees, generally someone who
earns more than $115,000 a year;
- • The program cannot provide more than 5 percent of its benefits to individuals who own more than 5 percent of the stock or capital or profits interest of the business;
- • The program cannot give employees a choice between cash (or other taxable benefits) and educational benefits; and
- • Reasonable notice about the plan is given to eligible employees.
If the program meets these requirements, then payment for tuition, books, equipment, fees, and supplies can be excluded from employees’ income. Importantly, the education can be an undergraduate course, graduate course, or other type of education; it need not be work-related or part of a formal degree program.
However, expenses for meals, lodging, and transportation are not excludable. And no dice on learning to play poker or tennis—expenses for courses involving sports, games, or hobbies do not usually qualify.
If more than $5,250 in educational assistance is provided, the excess is still deductible by the employer, but is taxable to the employee—that is, unless it qualifies as a working condition fringe benefit described next.
WORKING CONDITION FRINGE BENEFITS
Here is the second educational scenario employers should embrace: Employer-provided support that does not satisfy the requirements of a qualified educational assistance program may still be excludable from an employee’s income (and deductible by the employer) if it is considered to be a “working condition fringe benefit.”
This tax benefit is one that, had the employees paid it, they would have been able to deduct its cost as a business expense. To qualify, the education must:
- • maintain or improve the skills required to do the employee’s job, or
- • meet the express requirements of the individual’s employer, or requirements imposed by law or regulation, imposed as a condition of continued employment.
However, the education does not qualify for this benefit if:
- • the education relates to minimum educational requirements to obtain a job, or
- • it enables the taxpayer to begin working in a new trade or business.
This means that an accountant taking a course in cost accounting is a straightforward case of maintaining or improving skills so it qualifies. However, an engineer earning an MBA is not as upfront.
If the engineer currently has business or management responsibilities, the MBA is considered job-related and excludable; in this case, the education does not qualify him for a new “trade or business.” Otherwise, the education is taxable to the employee because it would qualify the employee for a new trade.
This area of the law can be complicated, and it pays to examine it before reaching a conclusion on whether education can be excluded as a working condition fringe benefit.
In order to make sure that the employee takes the education seriously and that the employer obtains the benefit of the educational cost, employers often attach conditions; there’s rarely a “free lunch.” The two most common conditions are a requirement that the employee continue working for the employer for some period of time after acquiring the education. The other is mandating that the employee obtain a certain grade level, such as a “B” or above. The tax law allows both types of conditions, and both make sense in discrete situations.
Employers who view their employees’ knowledge as important to the success of their business have two programs available to provide assistance to employees on a tax-favorable basis. Due to the programs’ inherent benefits and limitations, many employers maintain both types of plans.
Which plan makes the most sense for a firm? That depends on its goal.