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IRC section 127 permits employers to offer tax exempt fringe benefits in the form of tuition payments. This special treatment expired
at the end of 1994. In the Small Business Jobs Protection Act of 1996, Congress retroactively extended the tax exempt fringe through 1996. The new tax law limited the exclusion to tuition on undergraduate courses for courses beginning after June 20, 1996.

Taxpayers and tax advisors were placed in a quandary throughout 1995 regarding the proper treatment of tuition reimbursements. Most expected the fringe benefit to be reinstated retroactively. They asked themselves if they should--

* treat the tuition reimburse-ments as a taxable fringe and withhold taxes,

* attempt to handle the reimbursements as a tax exempt working condition fringe benefit, subject to the rules outlined in Treas. Reg. section. 1.132-5, or

* pretend that the fringe benefit was in fact retroactively reinstated before it actually was.

Those who treated the payments as taxable and filed accordingly, now have the opportunity to file for a refund of employment taxes and, in the case of the employee, income taxes.

Employees should file Form 1040X, Amended U.S. Individual Income Tax Return, to receive any income taxes paid on qualifying tuition reimbursements on which 1995 income taxes had been paid. Printed across the top of the Form 1040X should be the words "IRC 127." The employee should attach a form W-2c, Statement of Corrected Income and Tax Amounts, which should be prepared by the employer. If this is the only change for the employee, all he or she needs do is put their name, address, Social Security number, and tax year on the Form 1040X, sign the form, and attach the Form W-2c. Note, however, that the reduced income could cause the employee to qualify for the earned income tax credit, in which event a Form 1040, Schedule EIC should be attached.

Refunds of excessive 1995 and 1996 withheld taxes should be requested from the employer. If the employer cannot or will not refund these taxes, the employee should file a Form 843, Claim for Refund and Request for Abatement. Again, write "Section 127" at the top of the form. This refund is for excess FICA taxes and Medicare taxes.

If the employer refunds Social Security and Medicare tax to employees, it can report the adjustments on either Form 843, or Form 941 Employer's Quarterly Federal Tax Return. The refund must be explained on Form 941c, Supporting Statement to Correct Information.

Circular E contains general rules for the refund of employment taxes to an employer. Normally, the employer is required to obtain written statements from employees that they will not file duplicative refund claims. To expedite these section 127-related refunds, however, the employer need not obtain these written statements. However, if the statements are not obtained, the employer must--

* 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;

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

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

If a Form 843 is used,
the employer should print "Section 127" on the top.

The IRS may be contacted by taxpayers and advisors about this expedited pro-cedure by calling (800) 829-1040. *

Source: IR 96-36.

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