Can a sole proprietor pay $5,250 tax free toward student loans?
The educational assistance program was expanded by the the he Coronavirus Aid, Relief, and Eco-nomic Security Act, aka the CARES Act, to include certain employer payments of student loans paid after March 27, 2020. Originally set to expire after one year, the expansion has been extended through 2025. Payments up to $5,250 may be deducted as an employer expense and excluded from income for the employee. The employer must choose to offer this fringe benefit to their employees and meet certain requirements in order to qualify for the tax benefits.
If you're an employee you can ask your employer to opt into this program but it's at the employer's discretion. The employer is not obligated to offer an educational assistance program. The employee can't exclude these student loan payments without the employer adding it as a fringe benefit. If the employer does offer this benefit it's $5,250 above your compensation. The employer can't reduce your compensation in exchange for this benefit. I'm going to talk more about this later.
A fringe benefit is simply a benefit in your benefits packet.
The eligibility requirement according to the IRS, says, "The program benefits employees who qualify under rules set up by you that don't favor highly compensated employees. To determine whether your program meets this test, don't consider employees excluded from your program who are covered by a collective bargaining agreement if there is evidence that educational assistance was a subject of good-faith bargaining."
The program can limit eligibility through criteria added to the company's written plan such as types of coursework, degrees or grades. It just can't discriminate against certain classes of employees which is similar to retirement plan rules.
The amount of employees participating in this benefit may cause issues. In the context of the educational assistance program and specifically for the educational loan assistance, the IRS has outlined who is considered an employee.
- A current employee.
- A former employee who retired, left on disability, or was laid off.
- A leased employee who has provided services to you on a substantially full-time basis for at least a year if the services are performed under your primary direction or control.
- Yourself (if you’re a sole proprietor).
- A partner who performs services for a partnership.
I want to point out that a Sole Proprietor, by definition, is not considered an employee. It's an exception in this rule and it's important to know this because it's going to greatly affect many Sole Proprietor's eligibility. It's this next 5% rule that will likely limit Sole Proprietors from qualifying for this educational assistance program.
The program can't "provide more than 5% of its benefits during the year for shareholders or owners (or their spouses or dependents). A shareholder or owner is someone who owns (on any day of the year) more than 5% of the stock or of the capital or profits interest of your business."
You would need 19 employees using this benefit in order to qualify for the full $5,250 exclusion. 19 employees plus yourself multiplied by $5,250 would be $105,000. If you then multiple the max benefit for the Sole Proprietor of 5% by $105,000 you would get $5,250.
The last provision that is going to make this program highly unlikely to implement in my opinion is the use it or lose it factor. You can't offer an employee this benefit in lieu of cash compensation.
"A program must not provide eligible employees with a choice between educational assistance and other remuneration includible in gross income. For purposes of this section, the business practices of the employer (as well as the written program) will be taken into account."
As an employer you must give ample notice to your employees if you choose to offer it. It's also likely to be required in order to meet the nondiscrimination testing.
Unfortunately, this benefit appears to be significantly less valuable to employers than many originally thought. It also seems that it's geared for big business and not small business owners or Sole Proprietors.
I have attached links to section 127 of the tax code for educational assistance and publication 15-b from the IRS website that outlines the details of this program.