Tax Court Addresses Employer-Paid Tuition

Education expenses are not necessarily a tax-free benefit.

Church Finance Today

Tax Court Addresses Employer-Paid Tuition

Education expenses are not necessarily a tax-free benefit.

An employer paid an employee (“Jon”) an $8,000 “commission” in addition to his regular salary. Throughout his employment, Jon was enrolled at a local university earning an undergraduate degree. He had a verbal agreement with his employer that he would be reimbursed for certain educational expenses he incurred. Jon did not report the $8,000 as taxable income because he considered it to be a nontaxable “educational grant.” The IRS audited Jon, and determined that the entire $8,000 was taxable. Jon appealed, claiming that the $8,000 commission was not taxable on three separate grounds: (1) The commission was in reality a nontaxable qualified scholarship; (2) the commission represented employer-provided educational assistance; and (3) the commission represented an accountable reimbursement of a legitimate business expense (education). The Court rejected each of these arguments, and concluded that the commission was fully taxable.

(1) Qualified scholarship

The Court noted that the tax code excludes from taxable income “any amount received as a qualified scholarship by an individual who is a candidate for a degree” at certain educational institutions. However, a “qualified scholarship” does not include any amount received by a student which represents compensation for past, present, or future employment services. The Court concluded that the $8,000 was “a form of compensation and not the result of disinterested generosity,” and therefore it was not a nontaxable qualified scholarship.

(2) Employer-paid educational assistance

Section 127 of the tax code excludes from taxable income “amounts paid by the employer for educational assistance to the employee,” but only if the assistance is furnished pursuant to an “educational assistance program.” An “educational assistance program” is a “separate written plan of an employer” which meets certain requirements. The Court concluded that the $8,000 was not tax-free employer-paid educational assistance since “the amounts at issue were not provided pursuant to a written plan maintained by the employer as required by the statute.”

(3) Accountable business expense reimbursement

Jon argued that the $8,000 commission was nontaxable because it represented an accountable reimbursement of his education expenses. The Court conceded that an employer’s reimbursements of an employee’s business expenses are nontaxable to the employee so long as the expenses are substantiated under an accountable plan. Further, education can be a business expense, but only if (1) maintains or improves skills required by the employee in his or her employment, or (2) meets the express requirements of the employer, or of applicable law or regulations, in order for the employee to retain his or her job. The Court noted that Jon had not proven that his education met either of these conditions. In addition, expenses which fall within either of these two categories are not deductible if the education (1) is required in order to meet the minimum educational requirements for qualification in the taxpayer’s employment, or (2) qualifies the taxpayer for a new trade or business. The undergraduate education which Jon obtained “clearly qualified him for a new trade or business,” and therefore his education expenses were not business expenses that his employer could reimburse under an accountable plan.

Relevance to church treasurers. It is common for churches to pay some or all of the education expenses of an employee. This case illustrates that such payments are not necessarily a tax-free fringe benefit. To be nontaxable, they generally must meet the requirements for (1) a qualified scholarship; (2) employer-provided educational assistance; or (3) reimbursement of a business expense under an accountable plan. As the Tax Court noted in this case, each of these options has specific requirements that must be met. Since Jon met none of them, the $8,000 was fully taxable. This is an important lesson for church treasurers to keep in mind. Lewis v. Commissioner, T.C. Sum. Op. 2003-78 (2003).

This article first appeared in Church Treasurer Alert, September 2003.

Richard R. Hammar is an attorney, CPA and author specializing in legal and tax issues for churches and clergy.
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