August 5, 2012

Do you Have to Pay Taxes on Tuition Paid For by Your Employer?

Like many companies my employer has some free education benefits.   They will pay for me to go to graduate school assuming I get it approved.   I've heard its harder to get approval nowadays but theoretically I have the potential benefit to get free tuition.   Skimming over my employers website they mention potential tax implications.  

You may or may not have to pay taxes on tuition that your employer pays for you.
Generally here's the short answer :

  • If the benefit is under $5,250 then it should be tax free.
  • If the education provided is worth more than $5,250 then you may have to pay income tax on the amount over $5,250.   
  • If the benefit is required as part of your job then it may also be entirely tax free.

IRS Publication 970 addresses employer provided educational benefits.   There it says that

"If you receive educational assistance benefits from your employer under an educational assistance program, you can exclude up to $5,250 of those benefits each year. This means your employer should not include those benefits with your wages, tips, and other compensation shown in box 1 of your Form W-2. This also means that you do not have to include the benefits on your income tax return."

and then
"If your employer pays more than $5,250 in educational assistance benefits for you during the year, you must generally pay tax on the amount over $5,250. Your employer should include in your wages (Form W-2, box 1) the amount that you must include in income."

BUT they also mention a 'working conditions fringe benefit' saying " However, if the benefits over $5,250 also qualify as a working condition fringe benefit, your employer does not have to include them in your wages"   Then they point to Publication 15-B which covers taxation of fringe benefits.

In pub 15-B they say :

"Certain job-related education you provide to an employee may qualify for exclusion as a working condition benefit.  To qualify, the education must meet the same requirements that would apply for determining whether the employee could deduct the expenses had the employee paid the expenses.   The education must meet at least on of the following tests.
  • The education is required by the employer or by law for the employee to keep his or her present salary, status, or job. The required education must serve a bona fide business purpose of the employer.
  • The education maintains or improves skills needed in the job.
However, even if the education meets one or both of the above tests, it is not qualifying education if it:

  • Is needed to meet the minimum educational requirements of the employee’s present trade or business,
  • Is part of a program of study that will qualify the employee for a new trade or business."

All right thats pretty wordy.   Basically what it means is that IF the education is necessary to continue your current job then it can be a tax free benefit.   Also they say that education to obtain your current job or a different job doesn't qualify.

You might ask how they can count education required to maintain your job but exclude education to meet the minimum requirements of your job.     I believe the difference there is renewing your current level of education versus obtaining the level.  

Lets look at some examples
Lets say my company goes out and hires an engineer to do regulatory testing based on government rules.   To do this testing you need a special certification.    Every year you have to go take a week long refresher course and pass a test.   That week long class costs $15000 (expensive, I know) and the employer pays it.    You can't be a regulatory testing engineer in the industry without that certification.   This is one of the situations that meets the first bullet of education that is required by the employer or by law to maintain your current job.   The entire $15,000 amount is a tax free condition of working.

You're a civil engineer working for a construction company.   A new piece of software relevant to your job comes out and you take a course at the local university to learn how it works.  This would be a tax free benefit related to your job since it maintains or improves skills related to your job and it isn't something to qualify you for a different occupation nor a minimum requirement for your current job.

Now lets say my company goes and hires a senior in college a semester before they graduate.   They give this new hire a job as a regulatory engineer.   The new hire still hasn't graduated from college but the company is short of staff and decides to get a jump start on training the new hire.  They pay $10,000 for the new hire to finish school and $15,000 to take the certification class.  This new hire hasn't obtained the minimum requirements for their job and this would make the fringe benefit a taxable  item.   The total benefit was $25,000 but the first $5,250 is tax free.   That means the student could owe taxes on  $19,750 of the education benefit.

I am working as an engineer but I think I might want to instead be a pastry chef.  My employer pays $10,000 for me go to to night classes in culinary school.   This education has nothing to do with my current job and is intended for me to get a new career entirely.   This would be a taxable benefit.   I'd have to pay taxes on anything over $5250.  I'd have to pay taxes on the $4750 above the tax free amount.

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