Tax Liability Q&A: The Student Loan Repayment Program

The following Questions and Answers were provided by the Internal Revenue Service (IRS). For further guidance/clarification on these issues, agency representatives may contact IRS (Federal, State and Local Governments) at (202) 283-9665.

Employer's Tax, Withholding, and Reporting Obligations

Q1: If an agency repays the student loan incurred by an agency employee, is the repayment includible in the employee's gross income and in wages for Federal employment tax purposes?

A1. Yes. The repayment is includible in the employee's gross income and in wages for Federal employment tax purposes, notwithstanding the agency's repayment of the loan directly to the lender.

Q2: What are the Federal employment tax obligations of an agency that repays a student loan incurred by an agency employee?

A2: The agency must–

1. Pay the employer's share of social security and Medicare taxes on the loan repayment;

2. Withhold and pay Federal income tax withholding (and appropriate State and local income tax withholding) on the loan repayment;

3. Withhold and pay the employee's share of social security and Medicare taxes on the loan repayment; and

4. Report the loan repayment and taxes withheld and paid as required under Federal law and applicable State and local laws.

Q3: How must an agency report the repayment of a student loan incurred by an agency employee?

A3: The loan repayment must be reported as wages in Box 1 of Form W-2, Wage and Tax Statement, and as Medicare wages in Box 5 of Form W-2. If wages paid to an agency's employee are subject to social security taxes, the repayment is also reported as social security wages in Box 3 of Form W-2. The repayment is includible in social security wages, however, only to the extent that the repayment together with other wages previously paid during the calendar year does not exceed the social security wage base for that year.

Q4: How does a Federal employee report the repayment of a student loan by his or her employer?

A4: The repayment is reported as wages on line 7 of Form 1040 or, alternatively, on line 1 of Form 1040EZ.

Calculation of Employment Taxes

Q5: How does an agency calculate the amount of employment tax withholding due with respect to a loan repayment?

A5: One of two methods may be used–(1) the regular method or (2) the flat rate method. These methods apply because the loan repayments are supplemental wages paid in addition to regular wages. These two methods are described below and, more specifically, in Publication 15, Circular E, Employer's Tax Guide.

Q6: How does an agency calculate the amount of employment tax withholding due on supplemental wages (such as the loan repayment) under the regular method?

A6: To use this method the agency follows these steps:

1. The Federal agency calculates the correct amount of employment tax withholding on all wages paid during the payroll period by treating the supplemental wages and the regular wages as a single wage payment for the payroll period.

2. The Federal agency calculates the correct amount of employment tax withholding on the regular wages paid to the employee during the payroll period.

3. The Federal agency subtracts the amount determined in step 2 from the amount determined in step 1 to calculate the amount of any employment tax withholding due with respect to the supplemental wages.

Q7. How does an agency calculate the amount of employment tax withholding due on supplemental wages under the flat rate method?

A7. The correct amount of income tax withholding is calculated by taking a flat 25 percent of the supplemental wages. Social security tax and Medicare tax withholding are calculated at the usual rates and are in addition to the 25 percent income tax withholding.

Q8. When may an agency use the flat rate method of withholding on supplemental wages?

A8. The flat rate method of withholding on supplemental wages may be used if income taxes have been withheld from the regular wages of the employee. Consequently, if income taxes have been withheld from an employee's regular wages, an agency may use the flat rate method to determine the correct amount of income tax to be withheld with respect to the loan payment. The resulting employment taxes may be withheld from either the employee's regular wages, the loan repayment, or a separate tax payment made by the employee. (See Questions 10, 12, and 15.)

Withholding of Employment Taxes

Q9: What methods may an agency use to withhold income taxes and the employee's share of social security and Medicare taxes (employment taxes) when the agency repays a student loan incurred by an employee?

A9: An agency may use any of the following methods. Different methods may be used for different groups of employees. The agency may–

• Withhold employment taxes from regular wages paid to the employee as described in Question 10;

• Withhold employment taxes from the loan repayment as described in Question 12; or

• Require a separate tax payment from the employee as described in Question 15.

Withholding from Regular Wages

Q10: How does an agency withhold and pay employment taxes from regular wages paid to an employee?

A10: To use this method, the agency must–

1. Determine the correct amount of employment tax withholding on all wages paid to the employee during the payroll period, including both the loan repayment and regular wages. (The agency may use either the regular method described in Question 6 or the flat rate method described in Question 7 to calculate the correct amount of employment tax withholding on the loan repayment);

2. Deduct the total amount of employment tax withholding from the employee's regular wages; and

3. Deposit the amounts withheld and report them on Form 941, Employer's Quarterly Federal Tax Return, and Form W-2 in accordance with normal depositing and reporting procedures.

Q11: What if the agency does not process its own payroll but, instead, contracts with another agency to process its payroll?

A11: The agency making the loan repayment is responsible for transmitting the necessary information to the payroll agency and for ensuring that the withholding is properly implemented. If the agency processing the payroll is unable or unwilling to implement withholding, the agency repaying the loan must use one of the alternative withholding methods listed in Question 9.

Withholding from Loan Repayment

Q12: How does the agency withhold employment taxes directly from a loan repayment?

A12: To use this method, the agency must–

1. Calculate the correct amount of employment tax withholding on the loan repayment using one of two methods–the regular method described in Question 6 or the flat rate method described in Question 7;

2. Deduct the amount of employment tax withholding from the loan repayment; and

3. Deposit the amounts withheld and report the employment tax withholding and wages on Forms 941 and W-2 in accordance with normal deposit and reporting procedures.

Q13: May an agency that deducts the amount of employment tax withholding from loan repayments repay the $10,000 annually that is permitted?

A13: No. The deduction for employment tax withholding reduces the maximum loan repayment.

Q14: If an agency deducts the amount of employment tax withholding from the gross loan repayment, is the amount of the employment tax withholding and the net loan repayment includible in the employee's gross income and in wages for Federal employment tax purposes?

A14: Yes. However, the amount of income tax withheld is credited against the employee's income tax liability for the year.

Withholding from Separate Tax Payment

Q15: What are the obligations of an agency that requires employees to pay the agency an amount equal to employment tax withholding before the agency repays a student loan?

A15: An agency is obligated to pay amounts required to be withheld from an employee's wages even if those amounts are not actually withheld. Federal tax law requires agencies, like other employers, to withhold employment taxes from employees' wages. The repayment of student loans, however, may be subject to such terms, limitations, or conditions as the agency and the employee may mutually agree. Consequently, an agency's repayment of the student loan may be made contingent on an employee's payment of employment taxes (including income taxes and the employee's portion of social security and Medicare taxes) to the agency. In this case, to fulfill its tax obligations, the agency must–

1. Determine the correct amount of employment tax withholding on the loan repayment using either the regular method described in Question 6 or the flat rate method described in Question 7;

2. Obtain a check or other payment from the employee for the amount determined above;

3. Make the loan repayment and deposit and report on Form 941 an amount equal to the payment received from the employee in accordance with normal deposit and reporting procedures; and

4. Report the income, social security, and Medicare tax components paid by the employee in the appropriate boxes of Form W-2. These amounts are not included as income or wages in Boxes 1 , 3, and 5 of Form W-2.

Q16: May an agency treat the loan repayment as a noncash fringe benefit and use the withholding rules applicable to noncash fringe benefits?

A16: No. The rules for withholding on noncash fringe benefits do not apply to an employer's repayment of an employee's loan obligation.

Source: U.S. Office of Personnel Management