Help staff pay tuition via a deferred-pay plan

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in Small Business Tax,Small Business Tax Deduction Strategies

Parents on your staff face a big-time dilemma if they've got kids approaching the college years: How are they going to pay the ever-increasing tuition bills?

Advice: Set up a deferred-compensation plan to help them pay college costs. If you already have a plan in place, amend it to allow early withdrawals.

That type of plan can retain valuable workers and attract new talent. You could take advantage of this unique benefit yourself!

Best of all, the deferred-comp plan won't cost your company one penny more than it's paying now.

Put bonus in deferred college fund

Example: Say your company pays Sheila, a top young employee, a competitive salary for your industry. Also, you offer her the option of taking a $10,000 bonus at year-end or deferring the bonus.

By deferring the bonus, Sheila can't access the money until she leaves the company. Assuming she defers the bonus for 10 years while her child grows, Sheila accumulates $100,000 in the bonus account.

Since the plan is considered "unfunded" —meaning the bonus is tracked as a bookkeeping entry, not actual money—Sheila doesn't pay any income tax on the deferred amounts. (But federal payroll taxes apply to each year's deferred bonus.)

In comparison, if the plan is "funded," the bonus would be treated as if she received the deferred amount each year, so she would owe tax on each $10,000 bonus at the time it was declared.

Now, let's say your company amends the plan to let employees make withdrawals to pay for college expenses. In effect, there's no tax change for Sheila.

Reason: She doesn't owe any tax on the deferred-comp payouts until she actually receives the money. As an added incentive, your company can tack on an annual adjustment to reflect tuition increases.

What happens if Sheila's child doesn't go to college? No big deal. Your plan can include a provision that pays the deferred amount upon termination or resignation.

How does this affect your company's write-offs? Your company deducts the deferred compensation at the time it makes payments to employees. Not a problem, since you don't need to come up with the money before then.

Defer funds using 'rabbi trust'

Here's one hitch to an "unfunded" plan: The employee faces a risk of forfeiting the money. Naturally, most employees aren't comfortable with that arrangement.

How can you overcome that hurdle? Use a "rabbi trust" as the vehicle for deferring the bonuses. That way, employees keep a vested right to future payment, but the money isn't taxable each year because it's technically subject to the company's creditors. Ask your accountant how to set up such a trust.

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