The exclusion for employer-provided educational assistance, found in Section 127 of the Internal Revenue Code (IRC), allows workers to exclude from their taxes up to $5,250 annually in reimbursements or direct payments for tuition, fees, and books for certain courses. Section 127 was originally created by the Revenue Act of 1978 and has since expired and been reinstated eight times. Most recently, Section 127 was extended, retroactively, for the period of January 1, 1995 to July 1, 1997, in the Small Business Job Protection Act of 1996 (P.L. 104-188). After July 1, 1996, however, graduate courses can no longer be excluded from taxable income under Section 127.
The repeated expiration and reinstatement of Section 127 has increased the complexity of administering these benefits. Employers are unable to assure employees that the assistance will not be taxed. Furthermore, when the extensions are retroactive, the administrative burdens are multiplied by requiring employers to recalculate which previous benefits are now excludable for the employees. In response to the 1996 retroactive extension of these benefits, employers may need to:
- issue corrected W-2 forms (or W-2c forms) to employees.
- reimburse employees for 1995 Social Security and Medicare taxes.
- reduce their federal tax deposits to Social Security and Medicare for previous overpayments, and
- recalculate the base for contributions to retirement accounts as these benefits would no longer be included in employees' salaries.
Also, the unpredictability of receiving these tax benefits has prevent some workers from participating in the program. Some employees have postponed indefinitely registering for classes because of uncertainty about whether the benefits would be taxable. This issue affects both private and public employers, all of whom benefit from a more skilled and educated work force.
Section 127 does not require employers to offer educational assistance to their employees, nor are employees required to use these benefits. Rather, these benefits are an important way for employers, including state and local governments, to maintain a competitive, well-trained work force.
The Government Finance Officers Association (GFOA) supports making Section 127 a permanent part of the tax code for both undergraduate and graduate courses. Such a change would provide employers and employees with certainty regarding the deductibility of these benefits, reduce the administrative burdens employers experience as a result of the retroactivity of extensions, and remove the possibility of employees having unanticipated tax liabilities.
- Publication date: June 1997