Tuition benefits remain excluded after an initial employee transfer

Plain-English summary

An educational organization offered tuition reductions and scholarships for dependent children of eligible faculty and staff. It planned to transfer many employees to an affiliated nonprofit while retaining faculty and certain grandfathered non-faculty employees in the program. The IRS found that the current program and the program immediately after the initial transfer used reasonable employee classifications and passed the nondiscrimination safe harbor. Those benefits were qualified tuition reductions excluded from employee income and wages, with no related withholding or Form W-2 reporting. The IRS declined to rule on later annual employee transfers because they would occur at indefinite future times.

Ruling snapshot

• Question: Are the dependent-child tuition benefits excluded before and after the planned employee transfers?
• Outcome: Mixed: approved for the current program and immediately after the initial transfer; no ruling on later annual transfers.
• Key authorities: IRC §§ 117(d), 132(h), 170(b)(1)(A)(ii), and 414(q); Treas. Reg. § 1.410(b)-4.

Full text (IRS public release)

Internal Revenue Service Department of the Treasury
Washington, DC 20224

Number: 201516030 Third Party Communication: None
Release Date: 4/17/2015 Date of Communication: Not Applicable
Index Number: 117.06-00, 117.06-05
Person To Contact:
-------------------- -------------, ID No. ----------------
------------------------------------------------------------ Telephone Number:
--------- --------------------
----------------------------------------------------- Refer Reply To:
---------------------------------- CC:ITA:B05
---------------------------------------- PLR-126999-14
Date:
January 09, 2015

LEGEND:

Taxpayer = -----------------------------------------------------
University = -------------------------------
Corporation = --------------------------------------------------------------
Member = ----------------------------------------
Date 1 = --------------------------
Date 2 = ---------------------

Dear --------------:

   This is in response to your authorized representatives’ letter and submissions of

June 10, 2014 in which they requested on your behalf rulings under section 117(d) of
the Internal Revenue Code of 1986 (Code) regarding the proper federal income tax
treatment of certain tuition reduction benefits provided by you, Taxpayer, under
Taxpayer’s tuition assistance program (the Program), more fully describes below. We
are pleased to address your concerns.

FACTS

   The information submitted indicates that Taxpayer is an educational organization

described in section 170(b)(1)(A)(ii) of the Code. It is a corporation affiliated with and
under the control of University.

   University is a nonprofit corporation that is a tax exempt organization described

in section 501(c)(3) of the Code and an educational organization described in section
170(b)(1)(A)(ii) of the Code which provides undergraduate and graduate education.
University is the sole member of Taxpayer.
PLR-126999-14 2

   Corporation is a nonprofit corporation that is a tax-exempt organization described

in section 501(c)(3) of the Code. University and Member are the sole members of
Corporation, and each is a 50% member.

    The Program is designed to assist the faculty and staff of Taxpayer with the cost

of providing education for their dependent children. The Program applies to all full time
faculty and staff who have completed at least three continuous years of full-time service.
The Program is made up of two plans: “Plan A,” a tuition exemption program, and “Plan
B,” a tuition scholarship program. Under Plan A, eligible children enrolled at and
attending University pay 12% of the annual tuition in lieu of the normal tuition. Under
Plan B, eligible children actively enrolled in associate or baccalaureate degree
programs at other universities, qualified technical schools, or community colleges may
receive the lesser of a specific dollar amount or the cost of tuition and academic fees
the student is required to pay. All must be accredited institutions. There is an eight
semester or twelve quarter maximum per student and a lifetime maximum benefit per
employee for all dependent children receiving benefits under the Program.

  For purposes of the Program, and “accredited institution” is an institution listed in

“Accredited Institutions of Higher Education” published by the American Council of
Education for the Federation of Regional Accrediting Associations or a foreign institution
determined by University’s Provost to have standards equivalent to an American
Accredited institution.

    The term “eligible children” for purposes of the Program includes legally adopted

children, step-children, and dependent children of an employee’s same-sex spouse.
Eligible children must be younger than age 26 and substantially dependent upon the
employee. A child is eligible only if he or she does not yet hold an undergraduate
degree (baccalaureate or equivalent). A child’s eligibility continues for a maximum
period of one year if an employee takes an approved leave of absence. Eligible
children of employees who cease work due to disability remain covered for six months
following the employee’s cessation of work. The benefit also remains available for the
eligible children of employees who retired prior to January 1, 2012 at age 62 or older
and whose age plus years worked equaled at least 75, even if such employee has since
died.

    Taxpayer intends to amend the Program effectively Date 2 to limit “eligible

children” to children younger than age 24, with certain exceptions. Children who are at
least 24 years of age but younger than age 26 will be eligible if they were, prior to the
amendment date, enrolled in a program meeting the requirements of the Program upon
turning age 24 and have remained continuously enrolled since reaching age 24.
Further, children at least 24 years of age but younger than age 26 will also remain
eligible if their failure to enroll or remain continuously enrolled is a result of illness or
family emergency.

  As of Date 1, Taxpayer (including controlled affiliates) employed approximately

3,663 employees. Of these 3,663 employees, 919 are highly compensated employees
PLR-126999-14 3

(within the meaning of section 414(q)), of which 741 are eligible to participate in the
Program, and 2,744 are not highly compensated, of which 2,332 are eligible to
participate in the Program.

     As of Date 2, Taxpayer plans to transfer 1,921 of its current employees to

Corporation. The transfer will not affect the services the transferred employees provide.
It is intended that faculty and certain “grandfathered” non-faculty employees will not be
transferred from Taxpayer to Corporation and will continue to be eligible to benefit under
the Program. A non-faculty employee will be grandfathered and remain with Taxpayer if
on Date 2, (i) the employee had three or more years of service and (ii) the employee
had at least one child who is age 14 or older but younger than age 24, or who is age 24
or 25 and meets one of the exceptions described above (and in either case has not
already received the maximum amount of tuition concession benefit permitted under the
Program). Each January 1 after the initial Date 2 transfer of employees from Taxpayer
to Corporation, any grandfathered non-faculty employee who no longer has a child who
is age 14 or older but younger than age 24, or who is age 24 or 25 and meets one of the
exceptions described above (and in either case has not already received the maximum
amount of tuition concession benefit permitted under the Program) will be transferred to
Corporation.

REQUESTS

The taxpayer requests the following rulings:

   1. That the tuition benefits and educational assistance provided under the
      Program to eligible employees of Taxpayer with respect to the undergraduate
      education of their dependent children covered by section 132(h) of the Code
      currently satisfies the requirements of section 117(d), including the prohibition
      against discrimination in favor of highly compensated employees, and,
      therefore, are excluded from the employees’ gross income.

   2. That the tuition benefits and educational assistance provided under the
      Program to eligible employees of Taxpayer with respect to the undergraduate
      education of their dependent children covered by section 132(h) will,
      immediately after the proposed transfer of employees and amendment of the
      Program, satisfy the requirements of section 117(d), including the prohibition
      against discrimination in favor of highly compensated employees, and,
      therefore, will be excludable from the employees’ gross income.

   3. That, assuming the Program remains unchanged after Date 2 and continues
      to pass the objective portions of the non-discrimination test of section
      1.410(b)-4 of the Treasury Regulations, the tuition benefits and educational
      assistance provided under the Program to eligible employees of Taxpayer
      with respect to the undergraduate education of their dependent children
      covered by section 132(h) will, immediately after each subsequent proposed
      annual transfer of employees, satisfy the requirements of section 117(d),

PLR-126999-14 4

      including the prohibition against discrimination in favor of highly compensated
      employees, and, therefore, will be excludable from the employees’ gross
      income.

LAW AND ANALYSIS

   Generally, amounts paid to or for the benefit of employees are presumptively

compensatory in nature, and ordinarily includible in gross income as wages. Section
117(d)(1) of the Internal Revenue Code, however, provides a special rule in the case of
a “qualified tuition reduction:” section 117(d)(1) provides that gross income shall not
include any “qualified tuition reduction.”

   Section 117(d)(2) defines a “qualified tuition reduction” as the amount of any

reduction in tuition provided to any employee of a section 170(b)(1)(A)(ii) educational
organization for the education (below the graduate level) at such organization (or
another organization described in section 170(b)(1)(A)(ii)), of (A) such employee, or (B)
any person treated as an employee (or whose use is treated as an employee use)
under the rules of section 132(h). Section 132(h) refers, generally, to spouses and
dependent children of employees.

   Section 170(b)(1)(A)(ii) describes an educational organization as one which

normally maintains a regular faculty and curriculum and normally has a regular enrolled
body of pupils or students in attendance at the place where its education activities are
regularly carried on. An entity described in section 170(c)(1) or (2), or an institution that
is operated as an activity or function of such an entity, may qualify as an “educational
organization” described in section 170(b)(1)(A)(ii) for the purposes of section 117(d).

   Except for the case of certain graduate teaching and research assistance, the

exclusion from income provided by section 117(d) is limited to education “below the
graduate level.” Section 117(d)(5)[4] provides an exception for individuals who are
graduate students at the employing institution and who are engaged in providing
teaching or research activities for that educational institution.

    Section 117(d)(3) of the Code provides that the exclusion from income of a

qualified tuition reduction will apply to highly compensated employees only if such
reduction is available on substantially the same terms to each member of a group of
employees which is defined under a reasonable classification set up by the employer
which does not discriminate in favor of highly compensated employees (within the
meaning of section 414(q)).

   Section 1.410(b)-4 of the Income Tax Regulations generally provides the test for

determining whether a classification is reasonable and nondiscriminatory. That test has
two parts: (1) section 1.410(b)-4(b), requiring that the classification established by an
employer for its employees be reasonable; and (2) section 1.410(b)-4(c), requiring that
a plan pass an objective test to assure that the reasonable classification is
nondiscriminatory. The objective test has a safe harbor, an unsafe harbor, and a “facts
PLR-126999-14 5

and circumstances” test for situations falling between the safe and unsafe harbors. The
test applies with respect to the minimum coverage rules of section 410(b) and may be
incorporated into section 117(d), taking into account the differences between a qualified
retirement plan and a qualified tuition reduction plan. Nonetheless, although section
117(d)(3) prohibits discrimination in favor of highly compensated employees described
in section 414(q), there is no specific language in section 117(d) mandating that the
same coverage test applicable under section 410 are also applicable under section
117(d). Thus, the determination of whether a tuition reduction plan in fact discriminates
in favor of highly compensated employees for purposes of section 117(d)(3), is made
based upon an analysis of all relevant facts and circumstances.

    Section 1.410(b)-4(b) of the Regulations provides that a classification will be

reasonable if, based on all the facts and circumstances, the classification is reasonable
and established under objective business criteria that identify the category of employees
who benefit under the plan. Reasonable classification include specific job categories,
nature of compensation (i.e., salaried or hourly), geographic location, and other similar
bona fide business criteria. The House Ways and Means Committee Report on the
Deficit Reduction Act of 1984, H.R. Rep. No. 98-432, Part 2, 98th Cong., 2d Sess. 1606
(1984), provides additional examples of reasonable classifications. The report explains
that an employer could establish a classification based on such factors as seniority, full-
time vs. part-time employment, or job description, provided that the classification is
nondiscriminatory.

    Taxpayer is an educational organization described in section 170(b)(1)(A)(ii).

The tuition benefits and educational assistance provided under the Program are a
tuition reduction for the education (below the graduate level) at such organization or
another organization described in section 170(b)(1)A)(ii), of dependent children of
employees of Taxpayer covered by section 132(h). Accordingly, the tuition benefits and
educational assistance provided under the Program to eligible employees of Taxpayer
with respect to the undergraduate education of their dependent children covered by
section 132(h) meets the definition of qualified tuition reductions under section
117(d)(2).

    We have determined that, currently, the tuition benefits and educational

assistance provided under the Program to eligible employees of Taxpayer with respect
to the undergraduate education of their dependent children covered by section 132(h)
satisfies the “reasonable classification” of employees test of section 117(d)(3).
Additionally, these tuition benefits and educational assistance provided under the
Program, currently, satisfies the “safe harbor” test, and therefore, does not discriminate
in favor of highly compensated employees. Thus, the tuition benefits and educational
assistance provided under the Program to eligible employees of Taxpayer with respect
to the undergraduate education of their dependent children covered by section 132(h)
currently satisfies the requirements of section 117(d), including the prohibition against
discrimination in favor of highly compensated employees. Thus, these benefits are
excluded from the employees’ gross income under section 117(d)(1) as qualified tuition
reductions.
PLR-126999-14 6

    We have determined that, on Date 2, after the initial transfer of employees, the

tuition benefits and educational assistance provided under the Program will satisfy the
“reasonable classification” of employees test of section 117(d)(3). Additionally, on Date
2, after the initial transfer of employees, these tuition benefits and educational
assistance provided under the Program will satisfy the “safe harbor” test, and therefore,
will not discriminate in favor of highly compensated employees. Thus, the tuition
benefits and educational assistance provided under the Program to eligible employees
of Taxpayer with respect to the undergraduate education of their dependent children
covered by section 132(h) will, immediately after the proposed transfer of employees
and amendment of the Program, satisfy the requirements of section 117(d), including
the prohibition against discrimination in favor of highly compensated employees. Thus,
these benefits will be excludable from the employees’ gross income under section
117(d)(1) as qualified tuition reductions.

   Section 4.02(4) of Rev. Proc. 2014-3 provides that the Service will not rule on the

tax effect of any transaction to be consummated at some indefinite future time. Based
on section 4.02(4) of Rev. Proc. 2014-3, we are declining to make a determination on
the effect on the Program of future annual transfers of staff. Accordingly, we express or
imply no opinion regarding the satisfaction of section 117(d)(3) by the Program after one
of these future annual transfers.

CONCLUSION

   Based on the information provided and the representations furnished, we have

determined that the described tuition reduction benefits provided to employees (within
the meaning of section 117(d)(2) of the Code) of the Taxpayer for the education below
the graduate level of dependent children at any educational institution described in
section 170(b)(1)(A)(ii), are excludable from gross income of such employees under
section 117(d)(1) of the Internal Revenue Code as “qualified tuition reductions.”

   Also, based on the information provided and the representations furnished, we

have determined that, after the initial transfer of employees, the described tuition
reduction benefits provided to employees (within the meaning of section 117(d)(2) of the
Code) of the Taxpayer for the education below the graduate level of dependent children
at any educational institution described in section 170(b)(1)(A)(ii), are excludable from
gross income of such employees under section 117(d)(1) of the Internal Revenue Code
as “qualified tuition reductions.”

   Accordingly, the value of the described tuition reduction benefits granted under

Taxpayer’s Program to employees (within the meaning of section 117(d)(2) of the Code)
of the Taxpayer for the education below the graduate level of such individuals does not
constitute “wages” for purposes of section 3401(a). Additionally, such amounts are not
subject to section 3402 (relating to withholding for income taxes at source), section
3102 (relating to withholding under Federal Insurance Contribution Act (FICA)), or
section 3301 (relating to the Federal Unemployment Tax Act (FUTA)). Taxpayer is not
PLR-126999-14 7

required to file Form W-2, or any returns of information under section 6041, with respect
to such payment or remissions.

  However, we express or imply no opinion regarding the satisfaction of section

117(d) of the Code, or any other section of the Code, after any future annual transfer of
employees.

    This letter ruling is based on the facts and representations provided by the

Taxpayer and limited to the matters specifically addressed. No opinion is expressed as
to the tax treatment of the transactions considered herein under the provisions of any
other sections of the Code or regulations which may be applicable thereto, or the tax
treatment of any conditions existing at the time of, or effects resulting from, such
transactions which are not specifically addressed herein.

    Temporary or Final regulations pertaining to one or more of the issues addressed

in this ruling have not yet been adopted. Therefore, this ruling may be modified or
revoked by adoption of final regulations, to the extent the regulations are inconsistent
with any conclusions in this ruling. See section 11.04 of Rev. Proc. 2014-1, 2004-1
I.R.B. 1 at 50. However, when the criteria in section 11.06 of Rev. Proc. 2014-1 are
satisfied, a ruling is not revoked or modified retroactively, except in rare and unusual
circumstances.

     In accordance with the Power of Attorney on file with this office, a copy of this

letter is being sent to your authorized representative.

  Because it could help resolve federal tax issues, a copy of this letter should be

maintained with the Taxpayer’s permanent records.

    This ruling is directed only to the taxpayer who requested it. Section 6110(k)(3)

of the Internal Revenue Code provides that it may not be used or cited as precedent.

                                               Sincerely,



                                               William A. Jackson
                                               Branch Chief, Branch 5
                                               Office of Associate Chief Counsel
                                               (Income Tax & Accounting)