New Law Gives Tax Refunds
to Employees and Employers

WASHINGTON - Both employees and employers who participated in employer-provided educational assistance plans in 1995 or 1996 could be entitled to refunds because of recent tax law changes. The Internal Revenue Service has set up special procedures to make it easier to get these refunds and to expedite the processing of refund claims sent to the IRS.

The new law reinstates Internal Revenue Code Section 127's annual exclusion from income of up to $5,250 of educational assistance benefits, retroactive to January 1, 1995. However, the new law does not extend the tax benefit to graduate-level courses that begin after June 30, 1996.

Employees who previously paid taxes on employer-provided educational assistance can now get refunds of federal income, social security, and Medicare taxes paid in 1995 and social security and Medicare taxes paid in 1996. Employers can obtain refunds for social security, Medicare and unemployment taxes that they withheld and paid on benefits that are now eligible for exclusion. Employees will usually get the social security and Medicare tax refunds from the employer that provided the educational assistance.

If an employee's income and wages did not include these benefits for 1995, neither the employer nor the employee would be entitled to any refunds because they would not have paid income or employment taxes on the educational benefits.

Employee Income Tax Refunds -- Expedited Procedures

Employees who paid income taxes for 1995 on excludable educational assistance benefits are entitled to refunds. Employees can claim these refunds from the IRS by filing a Form 1040X, "Amended U.S. Individual Income Tax Return," if they have already filed a 1995 tax return. To do this, the employee needs to obtain from the employer a Form W-2c, "Statement of Corrected Income and Tax Amounts," showing the corrected wages for 1995, and needs to attach the Form W-2c to the Form 1040X.

For example, if an employee received a 1995 Form W-2, "Wage and Tax Statement," showing $26,000 in wages which included $4,000 of employer-provided educational assistance, the employer would issue a Form W-2c to the employee showing the corrected wages as $22,000.

To expedite the processing of these amended returns, taxpayers should print "IRC 127" in the top margin of the Form 1040X. If this is the only adjustment to the original return, taxpayers will need to put only their name, address, social security number and tax year on the Form 1040X, sign the form, and attach the Form W-2c. The IRS will compute the refund based on the Form W-2c data provided and will process these amended returns as quickly as possible.

Some employees with a Form W-2c showing corrected income of $26,673 or less for 1995 may now qualify for the earned income credit (EIC). These employees should read the EIC instructions in their 1995 Form 1040 tax booklets or Publication 596, "Earned Income Credit," and -- if they qualify for EIC -- also attach a completed Schedule EIC to the Form 1040X. Employees who claimed the earned income credit on their 1995 tax return do not need to complete another Schedule EIC. The IRS will automatically refigure their earned income credit.

Employee Social Security and Medicare Tax Refunds

For both 1995 and 1996, employees should request reimbursement of withheld social security and Medicare taxes from the employer who provided the educational assistance. Employers may add these reimbursements to employees' paychecks or make separate payments. Employees whose 1995 wages exceeded $61,200, or 1996 wages exceeded $62,700, -- not counting educational assistance -- would not have been subject to social security tax on the educational assistance payments and therefore would be entitled to only a Medicare tax refund.

If an employee is unable to obtain a refund of 1995 or 1996 social security and Medicare taxes from the employer, the employee may file Form 843, "Claim for Refund and Request for Abatement," with the IRS. The employee must attach to the Form 843 a statement from the employer listing any amount that the employer has reimbursed the employee, and any amount claimed -- or authorized by the employee to be claimed -- by the employer. If the employee cannot obtain this statement from the employer, the employee must explain his/her efforts to obtain this statement and must also provide, to the best of the employee�s knowledge and belief, the information that would be in this statement. As with the Form 1040X, a person filing Form 843 should include the "IRC 127" notation in the top margin to expedite the processing of the claim.

Employer Social Security, Medicare, and Unemployment Tax Refunds

Employers may be able to reduce their federal tax deposits after refunding social security and medicare tax overwithholdings to their employees. Adjustments should be reported on Form 941, "Employer's Quarterly Federal Tax Return," or Form 843 and must be explained on Form 941c, "Supporting Statement To Correct Information," or an equivalent statement providing the same information. Employers who reported these taxes on other employment tax forms should take the adjustment on those forms, and attach a Form 941c.

The rules governing employment tax refunds to employees and employers are summarized in Circular E, "Employer's Tax Guide." To expedite claims relating only to this reinstatement of the educational assistance exclusion, employers are not required to obtain the usual written statements from employees that they will not file duplicate refund claims. However, if an employer does not obtain these written statements, it must:

1 -- notify employees that the employer is claiming the refund on behalf of the employees, that the employees should not submit their own claims and that employees must notify the employer of any claims already submitted due to the reinstatement of the educational assistance exclusion, including any refunds or credits claimed on their 1995 Federal income tax returns;

2 -- refund the overcollected taxes to employees for amounts not already included in previous claims filed by the employees; and

3 -- state on the Form 941c (Part V) that the employer has done both of the above.

Employers who file a Form 843 to claim a refund of social security, medicare, and unemployment taxes should also print "IRC 127" in the top margin of that form to expedite the refund claim.

Effect on Retirement Programs and IRAs

For any employee entitled to a refund for 1995 due to the reinstatement of IRC Section 127, retirement programs and individual retirement arrangements (IRAs) are permitted to treat the employee's 1995 income as including the educational assistance that would otherwise be excluded under Section 127. In addition, the reduction in adjusted gross income that may result from retroactive reinstatement of Section 127 may allow some taxpayers who made nondeductible contributions for 1995 to an IRA to treat previously nondeductible 1995 IRA contributions as deductible. To do this, put the corrected nondeductible contribution amount on Form 8606 and attach it to Form 1040X.

Taxpayer Assistance

Employees and employers with questions about the retroactive reinstatement of the exclusion for employer-provided educational assistance may call the IRS at 1-800-829-1040. Taxpayers may obtain Forms 1040X, 843, 941c, Schedule EIC, Publication 596, and the related instructions, by calling 1-800-TAX-FORM (1-800-829-3676) or by using their computers to access the IRS home page at http://www.irs.gov or the Internal Revenue Information System bulletin board at 703-321-8020 (not a toll- free number).

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