Tax-Free Education Benefits: How Your Business Can Support Employee Learning While Saving on Taxes
- Steve Julal
- 2 days ago
- 3 min read
If you're looking for a strategic way to invest in your team and reduce your business's tax liability, consider setting up an educational assistance program under Internal Revenue Code Section 127. These plans allow employers to provide up to $5,250 per year in tax-free educational benefits to each eligible employee. These payments are exempt from federal income and payroll taxes and fully deductible as a business expense — making them a win-win for both the employer and employee.
What Does a Section 127 Plan Cover?
Section 127 plans can cover a wide range of education-related expenses, including graduate-level coursework — whether or not it relates to the employee’s current job. However, you as the employer, may choose to tailor the plan to cover only job-related courses. The parameters are completely up to the employer.
The benefit is strictly limited to employees, meaning expenses for spouses or dependents do not qualify. Also, courses related to sports, games, or hobbies are generally excluded — unless they are directly tied to the employee’s work responsibilities.
Key Requirements for a Section 127 Plan
To qualify for favorable tax treatment, your plan must meet specific criteria:
Written Plan Document: You must have a formal, written plan that exists solely for the benefit of your employees.
Nondiscrimination Rules: The plan cannot favor highly compensated employees or their dependents in terms of eligibility or benefits.
No Cash Option: Employees may not choose between educational assistance and cash compensation — meaning this benefit cannot be part of a cafeteria plan.
Pay-As-You-Go: Pre-funding isn’t necessary. You can reimburse or pay expenses as they’re incurred.
Employee Notification: Employees must be reasonably informed of the plan and how it works.
5% Ownership Limitation: No more than 5% of total annual benefits can go to employees who are more-than-5% owners, or to their spouses or dependents.
Can the Owner’s Child Participate?
Yes, with careful planning. An employee-child of the business owner can qualify for Section 127 benefits if:
They are age 21 or older,
They are a bona fide employee of the business,
They are not claimed as a dependent by the business owner, and
They do not directly or indirectly own more than 5% of the business.
Ownership attribution rules apply, meaning indirect ownership, such as through partnerships or family attribution for minors can disqualify them. However, once a child turns 21, parental attribution no longer applies, which may open the door for eligibility.
Special Considerations for Non-Corporate Businesses
If you operate as a sole proprietorship or an LLC, the same general ownership attribution concepts apply. Even without formal shares of stock, the IRS may treat indirect ownership interests as disqualifying if not properly structured.
Student Loan Repayment Option (Through 2025)
In addition to traditional education costs, Section 127 plans can temporarily be used to repay qualified student loans, including both principal and interest. This option is available through December 31, 2025, and is subject to the same $5,250 annual limit (combined with any other educational assistance benefits).
A Strategic Tool for Talent Retention
Offering education benefits through a Section 127 plan isn’t just a tax strategy — it’s a powerful recruitment and retention tool. Employees value opportunities to grow, and businesses that invest in their teams often see increased loyalty and productivity.
If you’re considering implementing an educational assistance plan or want to explore how your employee-child might qualify — contact our office. We can guide you through the setup process, help ensure compliance and align the plan with your overall tax and talent strategy.
