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Deducting Educational Assistance Expenses
The current economic downturn has forced many businesses
to reduce staff and evaluate the need to retrain employees. Fortunately,
the tax code permits employers to deduct the cost of educational assistance
programs, and employees can exclude from taxable income up to $5,250
of such benefits per year. This exclusion applies to assistance paid
for graduate and undergraduate courses that improve or develop the individual's
capabilities. The courses do not have to be job related or part of a
degree program and can qualify the employee for a new job. However, the
employer may condition payment on the employee completing the course,
attaining a certain grade, or satisfying a reasonable condition, such
as remaining employed for one year after completing the course. This ability
to encourage a desired behavior may give employers incentive to pay employee
education expenses.
Nondiscrimination rules prevent employers from providing
this benefit exclusively to owner-employees, their spouses, and dependents
who collectively own 5% or more of the company. No more than 5% of the amounts paid by the employer
can be provided for owner-employees, their spouses, and dependents. Thus,
it may be difficult for a closely held corporation with mostly owner-employees
to take advantage of this benefit.
If the program fails these requirements, payments for
both highly compensated and regular employees are taxable compensation.
Thus, the employer still deducts the payment, but it is taxable compensation
to the employee. The only exceptions are if the payments qualify as a
working condition fringe benefit (if the education is job-related) or
a qualified tuition reduction or qualified scholarship.
Note, however, that unlimited job-related educational
assistance is excludable from an employee's income as a working condition
fringe benefit. The exclusion is available for educational instruction
or training that improves or develops the employee's job-related capabilities.
Generally, education qualifies if it (a) is required
by an employer or the law to keep a present salary, status, or job; or
(b) maintains or improves skills required for present work. However, education
needed to meet minimum job requirements or that qualifies the employee
for a new trade or business does not qualify as a working condition fringe
benefit, but may qualify
for exclusion as noted above.
Tax Calendar
October 15 - Personal returns that received an automatic six-month
extension must be filed today and any tax, interest, and penalties due
must be paid.
-Electing large partnerships
that received an additional six-month extension must file their Form 1065-B
today.
November 2 - The third quarter Form 941 (Employer's Quarterly
Federal Tax Return) is due today and any undeposited tax must be deposited.
(If your tax liability is less than $2,500, you can pay it in full with
a timely filed return.) If you deposited the tax for the quarter in full
and on time, you have until November 10 to file the return.
-If you have employees, a
federal unemployment tax (FUTA) deposit is due if the FUTA liability through
September exceeds $500.
November 16 - If the monthly deposit rule applies, employers must
deposit the tax for payments in October for social security, Medicare,
withheld income tax, and nonpayroll withholding.
December 15 - Calendar-year corporations must deposit the fourth
installment of estimated
income tax for 2009.
Using
IRA Distributions to Pay Education Costs
Receiving penalty-free IRA
distributions before age 59˝ is possible in only a few cases. One such
case is for qualified higher education expenses for you or a dependent.
Another way is to elect to receive substantially equal periodic payments
for a period of time. But, if that series of payments is modified before
you reach age 59˝ a 10% penalty could apply.
However, the Tax Court recently ruled that an additional
distribution (above the substantially equal periodic payment) is permissible
if it was for qualified higher education expenses, because those expenses
also qualify for the exception. The good news is that if you are already
receiving periodic IRA payments prior to age 59˝, this Tax Court decision
indicates you should not have to worry about incurring a penalty if you
need additional funds from the IRA for certain college expenses for you
or your dependent.
Recent
Identity Theft Scams
The IRS frequently reminds
taxpayers to beware of identity theft scams. Two of the latest phishing
scams include one offering inherited funds, lottery winnings, or cash
consignment and another offering a bogus tax refund. Scammers use the
IRS name, logo, or website in an attempt to convince taxpayers that the
scam is a genuine communication from the IRS. Scammers may also use other
federal agency names, such as the U.S. Department of the Treasury. After
obtaining personal information, identity thieves use the victim's personal
data to steal his or her financial accounts, run up charges on the victim's
existing credit cards, apply for new loans, credit cards, services, or
benefits in the victim's name, and even file fraudulent tax returns.
Please note the IRS does not discuss tax account matters
by email. So, contact us if you receive an email, purported to be from
the IRS,
requesting personal information.
Borrowing
from Your 401 (k) Plan
Individuals who participate
in a 401(k) plan sometimes borrow from their plan. While you may justifiably
feel squeamish about taking out a 401(k) plan loan, it can actually make
good sense in appropriate circumstances-assuming it is paid back on time.
For instance, in today's tough economy, plan loans can be a source of
much-needed cash when bank loans are unavailable or prohibitively expensive.
401(k)
plan loans are generally economical and easy to obtain. In particular,
a 401(k) plan participant with less-than-stellar credit or tapped out
credit lines may find it much easier and cheaper to borrow from their
401(k) plan than from a commercial vendor.
401(k) plan loans provide participants with access (within
limits) to their 401(k) plan dollars without incurring income tax liabilities
and the 10% premature withdrawal penalty tax. The 10% penalty tax generally
applies to withdrawals before age 59˝, however, exceptions are available.
In essence, the participant (borrower) pays interest to himself or herself
when taking out a plan loan.
401(k) plan loans are only permitted if the plan document
allows them, and many plans do. The maximum amount that can be borrowed
is generally the lesser of $50,000 or 50% of the participant's (borrower's)
vested account balance. Most 401(k) plan loans are secured exclusively
by the participant's vested account balance (although other forms of security,
such as a lien against the participant's home, are sometimes seen).
At least two major potential pitfalls are associated
with 401(k) plan loans. First, the participant's account balance is irreversibly
diminished if the loan is not paid back. Second, the federal income tax
consequences are harsh for failure to pay back a plan loan according to
its terms, and the loan will usually have to be repaid in full soon after
the employee leaves the job for any reason. Such failure to repay the
loan can result in a deemed distribution of the unpaid loan balance that
triggers a federal income tax hit (possibly a state income tax hit, too).
In addition, the dreaded 10% premature withdrawal penalty will generally
apply unless the participant is age 59 ˝ or older.
Interest paid on a loan secured by the participant's
(borrower's) 401(k) plan account balance is non deductible if any of the
account balance used to secure the loan is attributable to elective deferrals
(i.e., elective salary reduction contributions the employee signed up
for). This is true regardless of how the loan proceeds are used and regardless
of the existence of other security for the loan, such as the participant's
home. Since 401(k) account balances will almost always include at least
some elective deferral dollars, interest on loans from such plans will
usually be nondeductible.
In most cases, borrowing from your 401(k) plan should
only be done when funds are not available elsewhere. But, during this
difficult economic time, it may be prudent to do so.
Please contact us if you have questions on the tax ramifications
of 401(k) plan loans or other tax compliance or planning issues.
Cash
for Unneeded Life Insurance Policies
Besides providing loved ones
with a source of funds for income replacement in the event of an untimely
death of the family's breadwinner(s), people buy life insurance for a
variety of reasons. These include, but are not limited to
- Funding a buy / sell agreement or key person insurance
for a business.
- Satisfying a lender's requirement when a loan was made.
- Funding anticipated estate taxes.
Whether it was one of these needs or something else,
circumstances change, and sometimes people find that they no longer need,
or perhaps can no longer afford, certain policies. In addition to affordability,
the policy may no longer be needed if-
- The key person in a business has retired, thus eliminating
the need for the policy.
- The business has been sold or business circumstances changed, eliminating
the need for the policy.
- Family circumstances have changed: (a) a mortgage or other loan was
paid off; (b) the kids have been educated or moved away from home; (c)
the policy's primary beneficiary has died; or (d) the insured went through
a divorce.
If
one of these describes your situation, consider whether it might be more
beneficial to sell the policy before you allow a term life policy to lapse
or before you turn in a whole life policy for its cash surrender value.
Known in the industry as a life settlement, selling a policy can sometimes
net the policyholder a sufficient sum that's far in excess of a whole
life policy's cash surrender value or a term policy's unearned premium.
Although such arrangements are still fairly new, the
IRS recently released guidance on the tax results of such a transaction.
If you have an unneeded policy that you're thinking about getting rid
of or just letting it lapse, we'd be glad to talk to you about whether
it might make sense to try to sell it instead.
Pease call us if you'd like to discuss this issue or
any other tax compliance or planning matter.
The
Tax and Business Alert is designed to provide accurate information regarding
the subject matter covered. However, before completing any significant
transactions based on the information contained herein, please contact
us for advice on how the information applies in your specific situation.
Tax and Business Alert is a trademark used herein under license.
© Copyright 2009