The IRS has released revised frequently asked questions (FS-2026-10) addressing educational assistance programs under Internal Revenue Code Section 127, replacing the FAQ issued in June 2024 (FS-2024-22). Although styled as “frequently asked questions,” the revisions represent substantive policy clarifications that affect tuition assistance programs and employer provided student loan repayment benefits. Employers that sponsor, or are considering sponsoring, Section 127 programs should review the changes carefully.
The new guidance includes a modified sample plan document (IRS Pub. 5993) that employers can use as a starting point to create a tax-favored employee educational assistance plan. Employers can modify the sample plan to include conditions for eligibility, such as prorated benefits for part-time employees (but subject to all of the Section 127 rules).
Section 127 in Brief
Section 127 allows employers to provide up to $5,250 annually in educational assistance to employees tax free, as long as the assistance is furnished pursuant to a written educational assistance program that satisfies statutory and nondiscrimination requirements. Qualifying benefits can include tuition; fees; books; supplies; and, since 2020, specified student loan repayment options. Those benefits are available for undergraduate or graduate courses at any college, university, vocational school, or other post-secondary educational institution as determined by the U.S. Department of Education. Courses can be job-related but do not have to be.
Key Updates in the Revised FAQ
Annual Exclusion Limit Will Be Indexed for Inflation After 2026
Section 127 educational assistance has been capped at $5,250 per employee per year for many years, with no adjustment. The revised FAQ clarify that while the $5,250 cap remains in effect for 2025 and 2026, the amount will be indexed for inflation thereafter. Unused amounts cannot be carried forward. Amounts exceeding the annual cap remain taxable unless another exclusion (such as for working condition fringe benefits under Section 132) applies.
BDO Insight
Employers should review plan documents, payroll systems, and benefit communications to be sure they can accommodate an indexed cap beginning in 2027.
Student Loan Repayment Benefits Are No Longer Temporary
Earlier IRS guidance reflected the statutory sunset of tax free student loan repayment benefits scheduled for January 1, 2026. The revised FAQ eliminate all references to that expiration, confirming that employer payments of principal and interest on qualified education loans might be provided indefinitely on a tax free basis under Section 127.
The FAQ also clarify that:
- Qualified education loans can be incurred before employment.
- Employer repayments for student loans can be made in later years, even if the loans were taken out and the education was provided before the individual was employed. That is different from other non-loan education expenses, which must be incurred while employed.
- Employer repayments can be made directly to a third party, such as the education provider or loan servicer, or directly to the employee.
BDO Insight
- Student loan repayment programs can now be designed as long term benefits, reinforcing their value as recruitment and retention tools.
- The employer’s Section 127 plan document generally must be drafted (or amended) to include the student loan benefit if the employer wants to offer the benefit as a feature of the plan (unless the plan document says it provides generally for all benefits allowed under Section 127).
- Not all student loan debt qualifies for tax-free employer payments and often includes a variety of expenses. Section 127 cannot be used for meals, lodging, transportation, tools, or supplies (other than textbooks) that the student can keep after the course ends. For example, student loan debt incurred to pay for a computer the student keeps is not eligible for Section 127 tax-free reimbursement. Employees must substantiate the expenses to the employer before Section 127 tax-free payments are allowed.
Employer Disclosure Obligations Are Now Mandatory
One of the more notable changes in the revised FAQ is the strengthening of employer communication requirements. Under prior guidance, employers were merely encouraged to inform employees about the availability of a Section 127 program. The revised FAQ state that employers must inform employees that a Section 127 program exists and disclose the program’s terms.
BDO Insight
- Employers should be sure that written communications such as plan documents, summaries, intranet postings, or on-boarding materials clearly describe the existence and terms of any Section 127 program.
- Employers generally cannot cherry-pick which employees are eligible to participate in a Section 127 plan. In contrast, employers can make tax-free education available as a Section 132 working condition fringe benefit to only some employees (including highly compensated employees or owners) if the education is job-related.
Benefits Must Be for the Exclusive Benefit of Employees
The revised FAQ clarify and expand IRS guidance regarding benefits provided to spouses and dependents. A Section 127 educational assistance program must be maintained for the exclusive benefit of employees, meaning that benefits generally cannot be provided to spouses or dependents unless those individuals are themselves employees.
Employees who are spouses and dependents of some shareholder employees, officers, or owners can receive tax-free education assistance, but the benefits for such spouses and dependents cannot exceed 5% of total program benefits provided during the year.
BDO Insight
Employers should review program eligibility rules to be sure spouse and dependent benefits do not inadvertently disqualify the program.
Expanded Focus on Officers, Shareholders, and Highly Compensated Employees
The revised FAQ broaden guidance addressing whether business owners and senior personnel can participate in Section 127 programs. Eligibility now includes officers, shareholders, owners, self employed individuals, and highly compensated employees. However, participation by those individuals is allowed only if the program continues to satisfy the Section 127 nondiscrimination rules and the special limitation on benefits for shareholders or owners of more than 5% of the capital or profits interests in the employer.
BDO Insight
Employers, particularly those with closely held ownership structures, should reassess nondiscrimination testing and benefit allocation. As a practical matter, if the owners are the only employees, the 5% benefit limitation prohibits them from receiving tax-free Section 127 education assistance.
Action Items for Employers
In light of the revised FAQ, employers should consider taking the following steps:
- Review and update Section 127 plan documents for inflation indexing and loan repayment provisions;
- Confirm that student loan repayment benefits are administered in compliance with the updated guidance;
- Implement or strengthen employee disclosures regarding the existence and terms of the program;
- Audit eligibility provisions, especially for owners, officers, and family members; and
- Coordinate with payroll and human resources to ensure proper tax treatment and reporting.
Conclusion
The IRS’s revised FAQ materially expand and clarify the operation of Section 127 educational assistance programs, particularly regarding student loan repayments, inflation indexing, and employer compliance obligations. While those changes enhance the long term value of educational assistance benefits, they also increase the importance of careful program design and administration. Employers should review their programs now to help ensure maximization of available tax benefits and continued compliance.
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