RC section 529 qualified tuition programs (QTPs) provide a tax-favored way to invest for qualified higher education expenses (QHEEs). While individuals usually contribute to benefit family members, nonindividuals also may contribute. Thus, employers may wish to fund QTPs as fringe benefits for employees. CPAs should understand the myriad tax issues.
Earnings accrue tax-free under section 529(c)(1) and distributions are tax-free under section 529(c)(3)(B)(i) when used to pay for a designated beneficiary’s QHEEs. Section 529(e)(1)(A) requires beneficiaries to be identified when QTP participation commences, though in certain cases, this decision can be postponed.
Employer contributions. There is no specific guidance on the treatment of employer contributions to QTPs for employees. Under one scenario transfers are completed gifts to a designated beneficiary but, under section 102(c), transfers by or for an employer to, or for the benefit of, an employee are not excludible from income as gifts. Because section 529 generally requires the designated beneficiary to be identified when participation begins, and because the employee would choose the beneficiary, contributions to QTPs made on an employee’s behalf would be deemed compensation to him or her under section 3401.
Assuming immediate vesting (so that the employee is treated as the account owner immediately), a cash-basis taxpayer and an arm’s-length transaction, the contribution would be both ordinary income to the employee and a completed gift to the designated beneficiary in the year paid. The employer would deduct the contribution in the year paid or accrued as a section 162(a) ordinary and necessary business expense. These contributions also appear to be taxable fringe benefits subject to section 3402(a) income tax withholding, and wages subject to Social Security and Medicare taxes.
For more information see “QTP Contributions by Nonindividuals” in the November 2004 issue of The Tax Adviser.
—Lesli S. Laffie,