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  What If I Hire My Kids, Can I Provide Them Tax-Free Education Benefits?

Reimbursements for Job-Related Education

Your business can cover certain educational expenses for an employee, treating these reimbursements as tax-advantaged working condition fringe benefits.

- For the employee, these reimbursements are exempt from federal income tax and federal employment tax. Great!

- For your business, these reimbursements are deductible as employee compensation expenses. Also great!

This beneficial federal tax treatment generally applies if:

- The education is required by your business, or by law or regulation, for the employee to maintain their current job; or

- The education maintains or improves skills required for the employee’s current job.

Good news: When these conditions are met, the favorable tax treatment is available for any employee, including those related to the business owner, such as a 22-year-old child employee.

Favorable tax treatment for working condition fringe benefits also applies when your business directly pays an educational institution for education that meets the above criteria.

If the education does not meet these criteria, such as education that prepares the employee for a new career, the payments are considered taxable wage compensation (unless processed through a Section 127 educational benefits plan, explained later). In either scenario, your business can deduct the costs as employee compensation expenses.

Undergraduate Degree Programs and Work-Related Education

The IRS considers an undergraduate degree as training for a new profession or business. Therefore, your business’s payments for an employee’s undergraduate degree, including for your child employee, cannot qualify as tax-free working condition fringe benefits.

The same applies to community college associate degrees.

The Tax Court has consistently upheld this IRS stance. Consequently, if your business pays for an employee’s undergraduate degree, those payments are taxable compensation for the employee. However, your business can still deduct these costs as employee compensation expenses.

Important: Although general employer reimbursements for undergraduate degree programs don’t qualify for tax-free fringe benefit treatment, the IRS informally indicates that each course must be individually evaluated. For example, if your employee-child is taking undergraduate accounting courses relevant to their work, your business might treat these reimbursements as tax-free working condition fringe benefit payments, even if part of an undergraduate degree program.

MBA Programs as Work-Related Education

The IRS also views an MBA as training for a new profession. Therefore, employer payments for MBA costs generally don’t qualify as tax-free working condition fringe benefits.

However, several Tax Court decisions have allowed tax-free fringe benefit treatment when the MBA program maintains or enhances skills used in the employee’s current job. The program’s potential to boost the employee’s resume and earnings doesn’t disqualify it from this tax benefit.

For instance, if your employee-child's role involves management and administrative duties, your business could treat MBA program payments as tax-free working condition fringe benefits.

Payments Through a Section 127 Educational Assistance Plan

Another option is setting up an educational assistance plan under Section 127 of the Internal Revenue Code. This plan can provide up to $5,250 annually in tax-free benefits for eligible employees.

Section 127 Plan Essentials

Section 127 plans can cover nearly any educational costs, including graduate coursework, regardless of job relevance. However, some businesses choose to cover only job-related education. This is up to you.

Your business can deduct payments made under a Section 127 plan.

To qualify, the education must be for the participating employee only, not for their spouse or dependents. Additionally, the plan cannot cover courses related to sports, games, or hobbies.

If the employee is a related party, such as the owner’s child, additional restrictions may apply.

Payments for Student Loans

 Until the end of 2025, a Section 127 plan can also make tax-free payments toward the      principal and interest on a qualified education loan taken out by a participating employee.

You have any questions? Please contact us info@arbstax.com