Putting Tax Law to Work: Benefit From Tax Deductions For Employee Education

Many owners and operators have long realized that employees are one of the major assets in their multi-unit or multi-brand franchise business. Franchise operations usually have quite a bit invested in hiring and training its workers. A smart owner or operator knows that improving a business asset can reap rewards far exceeding the cost of any improvements made. Similarly, the value of people to your organization improves with investments in additional training and education.

Government plans and programs have long contained tax provisions encouraging business owners to train or educate workers. In addition to a tax deduction for the employer footing the bill for employee training or education, another provision exists that allows the recipient of that educational benefit to ignore it as income for tax purposes.

Current tax law states that payments of up to $5,250 received by an employee (for tuition, fees, books, supplies, etc.) under their employer's educational assistance program may be excluded from the employee's gross income. Educational assistance also includes employer-led courses for employees.

Smith Stores, LLC, a hypothetical operator of several franchise businesses, established an educational plan for all of its regular, full-time employees. To receive benefits under this plan, participants were required to submit a written request to the Plan Administrator before starting the educational course. On completion of the course, the participants were required to provide original receipts for all items they submitted for reimbursement. The participating employee was required to attain a grade of "C" or better in order to receive future benefits.

The plan at our hypothetical multi-unit franchise business allowed participants to receive reimbursement for courses up to the tax rule's $5,250 limit. This plan also specifically permits employee reimbursement for courses that meet the definition of a "working condition fringe benefit"—in other words, courses offered by or taken for the benefit of the employer.

The tax law requires an actual plan. However, no actual fund will be established for payment of the benefits—nor can the benefits paid to participants be conditional on their making contributions to the plan. The business in our example pays the educational benefits out of its general assets.

Under the tax rules, no educational assistance plan or program is permitted to pay more than five percent of its benefits to principal (5 percent) shareholders or owners of the franchise operation or business. And the business is required to provide "reasonable" notice concerning the availability and terms of the plan to all eligible employees.

The IRS has approved our hypothetical company's plan as a qualified educational assistance plan. Therefore, the plan payments for educational expenses are excludable from the gross income of the employee. What's more, the tax rules permit employees to exclude as working condition fringe benefits, any amounts that are not excludable from their gross income under the basic plan. In addition, all payments made by our hypothetical multi-unit franchise operation—or any business with a similar plan—will be tax-deductible as ordinary and necessary business expenses.

There are restrictions

Despite the latitude given employers such as our hypothetical multi-unit franchise business, there are restrictions placed on educational assistance plans. Educational assistance, for tax purposes under the law, does not include payments for:

• any tools or supplies an employee keeps after completing the course;
• employee meals, lodging, or transportation;
• education that involves sports, games, or hobbies; or
• any graduate-level courses.

Any employer who maintains an educational assistance plan must maintain records and file an information return for the plan (Form 5500, "Annual Return/Report of Employee Benefit Plan," with Schedule F, "Fringe Benefit Plan Annual Information Return") .

For employees only

Many individuals attempting to foot the bill for their own education can benefit from a tax deduction available to help them slash their out-of-pocket expenditures. Educational expenses are generally tax-deductible by an employee (even an employee of his or her own business, and even if they lead to a degree) if the education that is undertaken: 1) maintains or improves a skill required by the individual in the individual's employment, trade, or business; or 2) meets the express requirements of the individual's employer, or the requirements of laws or regulations imposed as a condition to job retention, an employment relationship, status, or rate of compensation.

Consider the situation of John Doe. John is the self-employed owner of a multi-unit franchise business. He attends law school at night, and after completing studies receives a bachelor of law degree. John's expenditures while attending law school are nondeductible personal expenses because this course of study qualifies him for a new trade or business—whether he actually enters that new field or uses his new skills in his present business.

Educational expenses that are personal, or which constitute an inseparable aggregate of personal and capital expenditures, are not tax-deductible—even though they may maintain or improve a skill, or meet the express requirements of an employer. The minimum education necessary to qualify for a position is determined from a consideration of such factors as requirements of the employer, laws or regulations, and the standards of the profession, trade, or business involved.

A change in duties is not a new trade or business if the new duties involve the same general work as those in the taxpayer's present employment. Thus, changing from an elementary to a secondary school teacher, or from a teacher in one subject to another, does not result in a new trade or business. Also, a change in duties from classroom teacher to principal is not considered a change in trade or business.

Non-reimbursed expenditures for such items as tuition, books, laboratory fees, dues paid to professional societies, fees paid for professional journals, etc., are deducted by an employee as an itemized deduction, subject to the two percent floor on all itemized deductions. The cost of books of relatively permanent value used in connection with professional work is a capital expenditure and must be depreciated.

It is not unheard of for employees, especially those in skilled positions, to be offered scholarships or fellowships. Naturally, any amount received as a qualified scholarship by an individual who is a candidate for a degree at a qualified educational organization is excluded from that individual's gross income.

Under the tax rules, a qualified scholarship includes any amount received by an individual as a scholarship or fellowship grant, as long as the amount was used for qualified tuition and related expenses such as fees, books, supplies and equipment required for courses of instruction at a qualified educational organization.

Regardless of who foots the bill for education, the rewards of better-educated, better-trained employees are something every multi-unit or multi-brand franchise business owner or operator can take advantage of. Both business owners and their employees can help reduce the cost of that education with tax breaks. Education also makes an excellent fringe benefit that every owner and operator can employ to attract and retain employees.

Mark E. Battersby is a freelance writer, author, columnist, lecturer, and consultant specializing in taxes and finance for more than 30 years.