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Give—and get—a tax-free college savings boost

by on
in FMLA Guidelines,Human Resources

Paying for a child’s college education is a top priority for many middle-age employees. This can be an albatross around your neck, even if you’re a company owner or a high-ranking officer.

Fortunately, your company might be able to lighten the load.

Strategy: Create a private foundation to provide educational grants to employees’ children. So long as you meet certain requirements, the amounts are tax free to the employees.

The program can’t discriminate in favor of your children, but that doesn’t mean your kids can’t qualify as recipients. On the other hand, the IRS will object if you tilt the program in favor of top brass or if it’s used to disguise taxable compensation. Make sure that you level the playing field.

Here’s the whole story: Set up an independent committee to select the scholarship recipients. You can limit the grant applications to employees who have been with the company at least three years, but you can’t restrict eligibility based on position. And you can’t cut off a grant if the employee leaves the job afterward.

The IRS spelled out exact guidelines for securing tax-free treatment years ago. (IRS Revenue Procedure 76-47) They include the following seven requirements:

  1. The program can’t be used to recruit employees, induce them to stay with the company or follow another course of action for the employer. And the grants can’t represent past, current or future compensation.
  2. The selection committee must be totally independent of the employer or the foundation. Former employees are not to be considered independent.
  3. The program must have minimum eligibility requirements related to its purpose (e.g., children meeting standards required for admission). Eligibility can’t be based on employment factors such as position, services or duties.
  4. Selection must be determined by substantial objective standards unrelated to employment. A few examples are: high school grades, aptitude tests for higher education and teacher recommendations.
  5. Eligibility can’t be contingent on future employment. You cannot establish a requirement, either expressed or implied, that the employee will continue to work for the company.
  6. The course of study can’t be limited to areas that benefit the employer or the foundation. The recipient must have free rein to pursue his or her studies.
  7. The grants must otherwise be consistent with enabling the recipients to obtain their education solely for their personal benefit.

In addition to those requirements, the grants awarded in the year can’t exceed 25% of the number of applicants the selection committee considered, or 10% of the total number of eligible applicants (regardless of whether or not they actually applied for a grant).

Example: Say your small company has 20 employees with eligible children. Although three excellent candidates applied for grants in 2007, the private foundation can’t provide more than two scholarships for the year.

Tip: You must obtain advance IRS approval for the private foundation. If you don’t meet the percentage test and you satisfy all the other requirements, the IRS may still go along with the setup.

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