By Richard R. Hammar, J.D., LL.M., CPA
© Copyright 2001 by Church Law & Tax Report. All rights reserved. This publication is designed to provide accurate and authoritative information in regard to the subject matter covered. It is provided with the understanding that the publisher is not engaged in rendering legal, accounting, or other professional service. If legal advice or other expert assistance is required, the services of a competent professional person should be sought. Church Law & Tax Report, PO Box 1098, Matthews, NC 28106. Reference Code: m65 c0103
IRS addresses qualified tuition reductions. Many churches operate schools and offer “tuition discounts” to employees of both the school and church whose children attend the school. For example, a church operates a private school (K-12). The annual tuition is $2,500. The school allows the children of its employees to attend at “half” tuition. The same rate applies to the children of church employees. For 2002, tuition reductions are provided to the children of five school employees, and four church employees. Are there tax consequences to these tuition discounts? Do the tuition “reductions” represent taxable income to the parents, or are they nontaxable? Section 117(d) of the tax code specifies that "qualified tuition reductions" are not taxable. To be "qualified," however, certain conditions must be met. Among other things, the tuition reduction must be provided to an employee of an "organization described in section 170(b)(1)(A)(ii)" of the tax code. This section refers to "an educational organization which normally maintains a regular faculty and curriculum and normally has a regularly enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on." In the past, it has not been clear whether the IRS or the courts would consider an employee who works directly for a church to be an employee of an educational institution, even if the church operates a private school.
A recent IRS ruling addressed the eligibility of church employees for qualified tuition reductions, and concluded that they are not eligible for the exclusion. The IRS noted that nontaxable qualified tuition reductions must be provided by an educational organization described in section 170(b)(1)(A)(ii), which refers to schools. The IRS conceded, however, that a school that is "operated as an activity or function of" a church may qualify as an "educational organization" for purposes of section 117(d), even though not separately organized or incorporated. However, the IRS concluded that “an excludable [qualified tuition reduction] could not be extended to church employees who were not employed within the context of the school function, or educational organization. Thus, for example, a diocese operating a school system may not properly exclude from reportable wages as qualified tuition reductions . . . the value of tuition reduction benefits it might provide to employees of a hospital it also operates.” IRS Private Letter Ruling 200149030.