How the Plans Work
Employer-sponsored Sec. 127 educational assistance programs allow employees to receive tax-free educational benefits up to an annual limit ($5,250 for 2026). The benefits are excluded from the employee’s gross income for federal tax purposes. For employers, the amounts paid are deductible as business expenses.
But the plan doesn’t have to be pre-funded. You can pay or reimburse expenses as they’re incurred.
Eligible expenses include tuition, books, fees, supplies and equipment for coursework. However, certain expenses, such as meals, lodging or transportation — as well as tools or supplies that employees retain after completing a course — don’t qualify. Also ineligible are expenses for courses involving sports, games or hobbies unless they’re required as part of a degree program.
To qualify as a Sec. 127 program, the plan must be established in writing and meet specific requirements. The plan can benefit only employees — not their spouses or dependents.
Recent Enhancements
Tax legislation signed into law in 2025, commonly known as the One Big Beautiful Bill Act (OBBBA), made two important changes to Sec. 127 plans. First, it introduced an inflation adjustment to the annual cap. For tax years beginning after 2026, the $5,250 limit will be indexed for inflation (rounded down to the nearest $50), helping maintain the benefit’s value over time.
Second, the OBBBA made permanent the eligibility of employer payments for qualified student loans as a Sec. 127 expense. This means you can pay up to the annual cap toward an employee’s qualified student loan, and those payments will be excluded from the employee’s income.
Compliance Considerations
Sec. 127 plans must follow additional rules. For example, you can’t offer educational assistance as a choice between this tax-free benefit and taxable compensation, such as wages. And you must provide employees reasonable notice of the plan’s availability and terms.
Additionally, nondiscrimination requirements and ownership‑concentration limitations apply. For example, no more than 5% of total plan benefits for the year may be provided, in the aggregate, to employees who are more‑than‑5% owners of the business or to their spouses or dependents.
Rules for Family Employees
Sec. 127 plan benefits can extend to employees who are related to business owners, including children, as long as they’re bona fide employees and the plan satisfies applicable nondiscrimination requirements and ownership‑concentration limitations.
Ownership attribution rules may affect whether an individual is treated as a more‑than‑5% owner for these purposes, particularly in closely held businesses.
Taking the Next Step
Properly implemented Sec. 127 plans can help employers attract, develop and retain talent. Contact the office to discuss whether such a plan makes sense for your business.
