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Section 127 Tax-Free Education Benefits at Risk

Set to expire at the end of 2012 but now made permanent, Section 127 provides tax-free reimbursement for higher education

updated 1/2/2013

Update: On Jan. 1, 2013, Congress passed the American Taxpayer Relief Act of 2012 (H.R. 8), preventing the U.S. from going over the impending “fiscal cliff.” Signed into law the following day, the legislation permanently extends employer-provided education assistance (Section 127 of the Internal Revenue Code), which allows an employee to exclude from income up to $5,250 per year in educational assistance at the undergraduate and graduate level regardless of whether the education is job-related. See "'Fiscal Cliff' Bill Affects Payroll Tax Withholding and Employee Benefits."

Original article appears below

Among the many tax-related issues that Congress must resolve by Dec. 31, 2012, is the fate of Section 127 of the Internal Revenue Code. The key provision of Section 127 allows employers to provide tax-free reimbursement up to $5,250 for higher educational courses at the associate, undergraduate and graduate level. Congress has extended the provision 10 times since it was created in 1978, most recently in 2010. In some cases, the extension came after Section 127 expired, with the tax-free status of these benefits reinstated retroactively.

As of this writing, Section 127 is set to expire as of Jan. 1, 2013, unless Congress extends the law yet again.

The 2012 election may be over, but government revenue-related issues remain uncertain, making it difficult to predict whether Section 127 will be extended. “With all of the political rhetoric surrounding more educational opportunities and a better educated workforce here in America on the one hand, and closing tax loopholes on the other, it will remain to be seen what the government will do with respect to extending this benefit or letting it expire,” said Laura T. Kerekes, chief knowledge officer of Think HR Corporation in Pleasanton, Calif.

Still, there are compelling arguments to be made why Section 127 will be renewed when the time comes and others remain optimistic about the provision’s future. “It would be surprising if the tax treatment wasn’t extended,” said Jennifer Benz, founder and chief strategist at Benz Communications in San Francisco. “While it is currently set to expire at the end of the year, it’s been extended nine times since 1978 and is a popular benefit with bipartisan support among lawmakers, employers, and education and labor groups.”

Communicating Uncertainty

The uncertainty surrounding the future of these benefits creates a significant communication challenge for employers. While Benz argues that “there is no need for employers to extensively communicate to employees surrounding the Section 127 tax treatment,” others are not so sure.

“My general advice is for employers to communicate in the same way they would in any situation of uncertainty,” said Alison Davis, CEO of Davis & Company, an HR consulting firm based in Glen Rock, N.J. The most important thing for employers to remember is that transparency is key. Employers should explain candidly that they don’t know what will happen on this issue, but that they hope it will be resolved with an extension of these tax-free benefits. “ ‘We don't know what is going to happen’ may not be great communication, but it gives you credibility and authenticity,” said Davis.

Contingency Plans

Employers that consider these benefits essential to their value proposition may want to develop a contingency plan in the event that these tax benefits are not extended. Such a plan would need to address, among other things, whether the employer will “gross up” employees’ pay to help cover all or some of the tax on these benefits if the employer continues offering them.

The idea of grossing up employee pay may be particularly important for employers in industries with highly competitive labor markets and an ongoing need for employee development and knowledge expansion. “I wouldn’t be surprised if some employers go this route, if needed,” said Benz. “In that case, the communication really needs to reinforce the value of that additional benefit.”

Key Messages

Kerekes suggested that employers focus communications on four key messages:

  • An overview of the benefits the employer offers under Section 127 and what will change if the tax status of these benefits is not extended. In general, a change in tax status will mean that the employee may still get the same benefit, but that the value of that benefit will now be considered taxable to the employee.
  • Any changes the employer may make to these benefits if the tax status changes.
  • How the employer will handle taxation of the benefit from a payroll perspective, specifically any additional tax withholding that could result.
  • The fact that the employer is committed to keeping employees informed about the status of Section 127 and its renewal or expiration.

Davis advised that employers focus any Section 127 communication on those employees who are taking advantage of these benefits already. This way, the communication is more likely to reach those most affected.

“These employees are the ones who will be stuck if they find themselves in a new situation after signing up for transit passes and classes,” said Davis. Employers can help these employees by making sure that they know that “something may change with these benefits and here is how we plan to deal with it.”

Benz agreed, boiling the communication challenge down to this: Providing a “heads up” communication that is quick, simple and clear. Explain the history, the change and what it means; target the people who are using the affected programs (because they are the ones who will find this information the most valuable); and acknowledge what the organization knows and what it does not know and let employees know when to expect more information.

SHRM Urges HR Professionals to 'Get Involved'

The Society for Human Resource Management (SHRM) is urging HR professionals to ask their congressional representatives to retain the tax-exempt status of Section 127 benefits permanently .

“HR professionals know what a valuable tool Section 127 is to retain and attract talented workers,” said Kathleen A. Coulombe, senior associate with SHRM Government Affairs. “Without Section 127, employees may not choose to continue their education. This benefit not only assists the employee in their career endeavors, but ensures that employers remain globally competitive.”

Among the facts that show how Section 127 helps to build and maintain an increasingly skilled workforce: Almost 20 percent of Section 127 recipients are pursuing science, technology, engineering and mathematics (STEM) degrees. More than 35 percent of all degrees pursued by Section 127 beneficiaries are master’s degrees and, according to the National Postsecondary Student Aid Study, use of Section 127 benefits has doubled since 1994. Today, more than 1 million employees use Section 127 benefits.

Advice on contacting members of Congress is available on the SHRM Government Affairs’ “Get Involved” webpage. SHRM Government Affairs also has provided this fact sheet containing additional "talking points."

Joanne Sammer
is a New Jersey-based business and financial writer.

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