CAA 2021: A Game-Changer for Tax-Free Student Loan Repayment Benefits

by Prof. Robert Bloink and Prof. William H. Byrnes

Student loan debt is a substantial burden for millions of American workers. One of Congress’s responses to the COVID-19 crisis was to offer a way for employers to help their employees pay down student loan debt on a tax-free basis. The CARES Act allowed employers to offer up tax-free student loan relief for one year only—and that relief was later extended through 2025. Studies show that student loan repayment assistance can be a powerful employee retention tool, especially in today’s challenging employment market. The COVID-19 pandemic has changed the job market in unprecedented ways—and traditional benefits, such as tax-free transportation benefits, have become less important to millions of Americans in a work-from-home culture. For small business clients who are struggling to retain talented employees, this new student loan repayment benefit could offer an attractive solution.

Expanded Student Loan Assistance Availability Under CAA

Under prior law, employers had the option of providing employees with tax-free benefits for qualifying educational expenses, like tuition, books and other education-related expenses. Under the CARES Act, the definition of "educational assistance" was expanded and changed to include payments to an employee for either the principal or interest on student loans, as long as the payment was received before January 1, 2021. The Consolidated Appropriations Act of 2021 (CAA) extended the availability of tax-free student loan repayment benefits through 2025.

Employers are permitted to contribute up to $5,250 per year, per employee to a qualified education assistance program (EAP). The employee can then use those funds to cover qualifying educational expenses, like student loan payments.

Despite the attraction of student loan assistance as an employment benefit, prior to 2021, the downside to the benefit was that the option was available only for 2020. Because employers were required to adopt a formal EAP under IRC Section 127 in order to offer student loan relief to employees, few employers decided to take advantage of the opportunity.

However, the CAA makes the tax-free student loan repayment benefit available through at least January 1, 2026—encouraging many more employers to explore the option of this employee retention tool.

IRC Section 127 Plan Considerations

Amounts received pursuant to a Section 127 EAP are excluded from the employee’s income—whether or not the educational expenses are in any way job-related. The contributions are also tax-exempt to the employer. Any qualified education loan is eligible for tax-free repayment assistance, as long as the loan was incurred by the employee for his or her educational purposes. Currently, the funds must be used to cover the employee’s own student loan debt.

However, employers do have to satisfy several different qualification requirements for the benefits to be received tax-free. The employer is required to adopt the plan via a formal written document—and employees cannot be offered the choice between the Section 127 benefit and another benefit that is included in income.

Student loan repayment assistance has to be offered in a non-discriminatory manner. In other words, employers cannot elect to offer the repayment benefit to only highly compensated employees or those with more than a 5 percent ownership interest in the company. In fact, no more than 5 percent of the benefits paid out annually can be for those with a 5 percent ownership interest, including their spouses and dependents of more-than-5-percent owners. In 2021, a highly compensated employee is one who earns compensation in excess of $130,000 per year.

When determining the per-employee contribution rate to the program, rates can be based on reasonable employment classifications—such as status as a full-time employee or part-time employee. Those classes, however, must also be determined on a non-discriminatory basis.

The employer also has to ensure that employees receive adequate notice that the program and benefits are available.

Conclusion

Studies show that about 62 percent of Americans with student loan debt would consider changing jobs to gain access to a student loan relief benefit. While EAPs have always been a valuable tool, using the EAP to pay down student debt on a tax-free basis gives employers a meaningful way to help employees who have struggled with this debt burden for years.

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