How to Afford a Racoon Coat

As a father of two sons in college, I read with some interest the CRS report, Federal Taxation of Student Aid: An Overview, by Linda Levine (no relation) and Bob Lyke. The report summarizes the tax treatment of various sorts of aid and other income typically used to fund college education.

The report contains a concise description of one of the richest, yet little known, tax provisions relating to tuition funding:

Tuition reductions for employees of educational institutions can be excluded from gross income if they are (1) restricted to education below the graduate level . . . (2) do not discriminate in favor of highly compensated employees, and (3) do not apply to amounts representing payment for services. The last restriction is identical to the one just discussed for scholarships: amounts that represent payment for teaching, research, or other required activities must be included in gross income and may be subject to FICA taxes. Only reductions in excess of such deemed payments are excludable (these excess amounts are like scholarships).

Tuition reductions are excludable even if they are made for the employee's spouse and dependent children; they can also occur at schools other than where the employee works, provided they are remitted by the school attended, not paid by the employee's school. For example, college A could reduce the tuition of students who are children of teachers employed by college B, and neither the students nor parents would have to include the remissions in their gross income.

Hat Tip to Terry Cuff.