Question

Page 5-7 (Section 5-4a) of the text mentions “qualified tuition reduction plans” under which an educational institution may reduce or pay the tuition for its employees, and the employees will not be taxable on the assistance.

• What criteria are used to determine whether the employer qualifies to provide nontaxable qualified tuition reductions or payments under such a plan?
• Which individuals may receive the nontaxable qualified tuition reductions or payments?
• Are there circumstances in which a tuition reduction or payment made by a qualifying employer for a qualifying individual will nevertheless be taxable to the employee? If so, describe these circumstances.

Answer 1

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A elligible educational institution can exclude the amount of a qualified tuition reduction it provides to an employee from the employee’s wages. According to the IRS, an eligible educational institution is “an institution that maintains a regular faculty and curriculum and normally has a regularly enrolled body of students in attendance at the place where it carries on its educational activities.”

The rules for determining if a tuition reduction is qualified, and therefore tax free, are different if the education provided is below the graduate level or is graduate education

A tuition reduction for undergraduate education generally qualifies for this exclusion if it is for one of the following types of individuals:

A current employee

A former employee who retired or left on disability

A widow or widower of an individual who died while an employee

A widow or widower of a former employee who retired or left on disability

A dependent child or spouse of any individual listed in these categories

A tuition reduction for graduate education qualifies for this exclusion only if it is for a graduate student who performs teaching or research activities for the educational organization.

Qualified tuition reductions apply to officers, owners, or highly compensated employees only if benefits are available to employees on a nondiscriminatory basis. This means that the tuition reduction benefits must be available on the same basis to each member of a group of employees, which is defined by the employer. This classification must not discriminate in favor of owners, officers, or highly compensated employees.

Section 414(q) of Internal Revenue Code details two tests for determining if an employee is a Highly Compensated Employee (HCE )– an ownership test and a compensation test. An employee is considered an HCE if he or she satisfies either of these tests.

Ownership Test: Generally, an employee that is a 5% owner at any time during the current plan year, also known as the determination year, or the 12-month period immediately preceding the determination year, also known as the lookback year

Compensation Test: An employee who has received compensation from the employer in excess of $80,000 during the lookback year and, if elected by the employer, is in the top 20% of employees ranked by compensation for the lookback year. The employer may make the election for any year and it will be applicable for all subsequent years until it is revoked. There is no filing or reporting requirement with the Service. However, the plan document must be consistent with the election, so a plan amendment may be required to reflect the election, depending upon the terms. For more information, please see Sections IV, V and VII of Notice 97-45.

An employer with a non-calendar year plan can elect to have the lookback year be the calendar year that begins with or within the 12-month period immediately preceding the determination year. This election may not be made for the ownership test. The requirements for making a calendar year election are set forth in Section V of Notice 97-45.