Educational Assistance Programs Now Cover Student Loans

A benefit that was scheduled to disappear at the end of 2025 is now permanent, and almost nobody has updated their plan documents.

Under Internal Revenue Code section 127, a business can pay up to 5,250 dollars a year toward an employee’s education, tax free to the employee and free of payroll tax for the company. Since 2020 that has included paying down the employee’s student loans. That student loan piece was temporary, with a hard expiration date of December 31, 2025.

It is now law with no sunset. Which makes this a reasonable time to look at whether the benefit fits your business — and to be honest about the one rule that makes it useless for most small ones.

What changed for employer paid student loans

Publication 15-B for 2026 puts it directly in its What’s New section. Public Law 119-21 “permanently extends the $5,250 exclusion from income for employer-provided educational assistance for payments made after 2025.”

The same publication describes what the loan piece covers. Payments of principal or interest on a qualified education loan incurred by the employee for their own education, made either to the employee or directly to the lender. Both directions work, which is worth knowing when you design the mechanics.

There is a second change worth planning around, and it does not take effect yet. Revenue Procedure 2025-32 states that section 70412 of the One Big Beautiful Bill Act made the student loan provision permanent, and that “the maximum exclusion amount of $5,250 will be adjusted for inflation for taxable years beginning after 2026.”

So the figures to work with right now are these.

• The 2026 limit is 5,250 dollars per employee, the same figure that has applied since 1986
• Inflation indexing begins for taxable years beginning after 2026
• The first indexed amount will appear in the revenue procedure issued for 2027 figures
• Unused amounts do not carry forward to a later year
• The limit is a combined cap covering tuition and student loan payments together, not separate buckets

That last point catches people. An employee taking 5,250 dollars of tuition support has nothing left for loan payments in the same year.

What counts as educational assistance and what does not

The IRS refreshed its guidance on this in April 2026, and the updated frequently asked questions are the most current source available. Note that the older 2024 fact sheet is still live at its original address and still recites the December 2025 sunset, so it is worth checking which version you are reading.

Qualifying expenses include tuition, fees and similar expenses, books, supplies, and equipment. Graduate-level courses count, which contradicts a widely held assumption that section 127 is undergraduate only.

The exclusions are specific.

• Meals, lodging, and transportation
• Tools or supplies, other than textbooks, that the employee keeps after the course ends
• Courses involving sports, games, or hobbies, unless the education has a reasonable relationship to your business or is required as part of a degree program

One requirement gets overlooked more than any other. The employee must be able to substantiate to the employer that the assistance went to qualifying expenses. The obligation sits with the company, not the employee, which means the plan needs a documentation step built into it rather than bolted on later. Building that step into how the business already operates is exactly the kind of detail our tax planning work exists to handle before it becomes a problem on examination.

The written plan rules you cannot skip

A section 127 benefit is not a decision to reimburse tuition. It is a separate written plan, and it has to satisfy four tests to work.

1. The program must benefit employees under rules that do not favor highly compensated employees
2. No more than 5 percent of the benefits paid during the year may go to owners and shareholders, or their spouses or dependents
3. The program cannot let employees choose cash or other taxable benefits instead of educational assistance
4. You must give reasonable notice of the program to eligible employees

For 2026, a highly compensated employee is someone who was a 5 percent owner during the year or the preceding year, or who received more than 160,000 dollars in pay for the preceding year. There is an option to disregard that pay test if the employee was not also in the top 20 percent of employees ranked by pay.

The written plan requirement is not a formality you can satisfy after the fact, and the IRS has made it unusually easy to meet. It publishes Publication 5993, a sample educational assistance program, revised in April 2026 to reflect the new law. It is an actual model plan document rather than a description of one.

Getting the document right and getting the strategy right are separate questions, and the second one is where most of the value sits. That distinction between compliance work and forward-looking work is the subject of our post on tax planning versus tax preparation.

The 5 percent owner limit that stops most small businesses

This is the part that gets left out of nearly every article on this benefit, and it is the part that determines whether the strategy is available to you at all.

Start with the good news. Publication 15-B’s list of who counts as an employee for this exclusion is generous. It includes a current employee, a former employee who retired or was laid off, certain leased employees, yourself if you are a sole proprietor, and a partner who performs services for a partnership. Sole proprietors and partners are expressly in.

Now the constraint. Not more than 5 percent of the amounts paid under the program during the year may go to the class of individuals who own more than 5 percent of the stock, capital, or profits interest — including their spouses and dependents. There are two distinct 5 percent thresholds in that sentence, and conflating them is easy. One defines who is in the limited class. The other caps what the class can collectively receive.

Publication 15-B then says the quiet part out loud. “If the owners are the only employees, they can’t receive educational assistance under section 127 of the Internal Revenue Code because of the 5% benefit limitation.” It supplies the formula. Multiply the total assistance provided to non-owner employees by 5.263158 percent, round down, and cap at 5,250 dollars.

Run that math and the practical rule emerges. It takes roughly 19 other employees each taking the full 5,250 dollars before an owner can take a full 5,250 dollars themselves. With eight non-owner employees at the full amount, the owner’s ceiling is about 2,210 dollars.

For a solo owner or a three-person shop, this benefit is not a strategy. It is unavailable, and any advisor telling you otherwise has not read the limitation.

There is a related trap for family employment. A spouse or child can be covered only in their own capacity as an employee — the program cannot cover an employee’s family members as family members. And if that family member is the spouse or dependent of an owner above the 5 percent threshold, they land inside the limited class rather than creating room outside it. Hiring your child does not manufacture headroom here, though it can be a sound strategy for other reasons, which we cover in employing your children. The IRS announced the April 2026 refresh in its news release on section 127 programs, which is the citation to keep on file.

One honest caveat on S corporations. Publication 15-B expressly disqualifies a 2 percent S corporation shareholder from several other fringe benefits, and it does not include that exclusion in the educational assistance section. That silence is favorable but it is an inference, not IRS guidance, and section 1372 of the code treats a 2 percent shareholder as a partner for fringe benefit purposes. The IRS has not addressed how those two provisions interact for section 127. Anyone who states the answer confidently in either direction is going beyond the published guidance.

When a working condition fringe benefit works better

Section 127 is not the only route, and for a small business it is often the wrong one.

Section 132 allows an employer to provide education as a working condition fringe benefit with no dollar cap at all. The trade-off is a different test. The education must be job related — the IRS frames it as education you could have deducted as an employee business expense in relation to the employer’s trade or business.

The two provisions sit almost exactly opposite each other.

• Section 127 covers any subject, including education unrelated to the job, but caps out at 5,250 dollars and requires a written nondiscriminatory plan
• Section 132 has no dollar limit but requires the education to maintain or improve skills required in the employee’s present work, or to be required by the employer or by law

Publication 970 supplies the job-related tests in its chapter on work-related education. Education fails those tests if it meets the minimum requirements of the present trade or business, or if it qualifies the employee for a new trade or business. An MBA for a controller may qualify. Law school for that same controller generally does not.

The two can stack. Publication 15-B contemplates exactly this, noting that assistance exceeding 5,250 dollars must be included in wages “unless the benefits are working condition benefits.” For a business investing seriously in one key employee’s development, the combined analysis is usually where the answer lives. There is a related no-double-benefit rule to respect as well — expenses covered by tax-free employer assistance cannot also support an education credit or the student loan interest deduction. Our post on tax strategies for owners sending kids to college covers where the family side of that analysis fits.

How to decide whether this belongs in your plan

Work through it in this order and the answer usually becomes obvious quickly.

Count your non-owner employees and how much assistance they would realistically use. Multiply by 5.263158 percent. If the result is a number too small to matter, section 127 is not your strategy this year — and knowing that saves you the cost of a plan document you would never use.

If the number is meaningful, the benefit is real and worth building properly. Adopt a written plan modeled on the IRS sample. Give notice to eligible employees. Build the substantiation step into your process. Confirm the payroll treatment, since qualifying amounts are exempt from income tax withholding, Social Security and Medicare, and federal unemployment tax, and are simply left out of Box 1 rather than reported in a special box.

That sequencing — establish whether a strategy applies before building it — is how we approach every strategy we recommend, and it is why our list of business tax planning strategies starts with fit rather than with tactics. It is also the difference between a plan and a list of ideas, which is what our clients tend to notice first, as our reviews reflect.

Let us tell you whether this one applies to you

Educational assistance is a good example of a strategy that reads well and works for a specific shape of business. If you have a real payroll and a team investing in credentials, it is money you are currently leaving on the table. If you are the only employee, it is a distraction.

We would be happy to take a look and tell you which one you are. Schedule a no-obligation evaluation and we will run the numbers against your actual payroll before recommending anything.

Frequently asked questions

Q: How much can an employer pay toward student loans tax free

A: Up to 5,250 dollars per employee for 2026, combined across tuition and student loan payments rather than separately. Inflation indexing of that figure begins for taxable years beginning after 2026.

Q: Did the student loan repayment benefit expire at the end of 2025

A: No. Publication 15-B for 2026 states that Public Law 119-21 permanently extends the exclusion for payments made after 2025. Some older IRS pages still recite the original December 2025 expiration date, so check the revision date on whatever you are reading.

Q: Can the owner of a small business use this for their own tuition

A: Only within the 5 percent limitation. Publication 15-B states that if the owners are the only employees they cannot receive educational assistance under section 127, and it provides a formula tied to what non-owner employees receive.

Q: Does the education have to be related to the employee’s job

A: Not under section 127. The IRS states the payments do not have to be for work-related courses. The separate working condition fringe benefit under section 132 does require job-related education, but it has no dollar cap.

Q: Can I cover my employee’s spouse or children

A: Not as family members. The program must be for the exclusive benefit of employees, so a spouse or child can be covered only if they are themselves an employee. If they are the family of an owner above the 5 percent threshold, they fall inside the limited class.

Q: Do educational assistance payments appear on Form W-2

A: Qualifying amounts are left out of Box 1 and there is no dedicated box or code for them. Amounts above the annual limit become taxable wages unless they independently qualify as a working condition fringe benefit.

Q: Can an employee still claim an education credit for the same expenses

A: No. Expenses covered by tax-free employer educational assistance must be excluded before figuring an education credit, and employer-paid student loan interest cannot also support the student loan interest deduction.