A Cost-Free Employee Incentive Available to Maine Employers
(An Employer’s Guide to Maine’s Educational Opportunity Tax Credit)
Nate Marcet, Tax Senior
Created in 2008, the Maine Educational Opportunity Tax Credit has benefited many Maine employees and employers alike. Previous articles published by Baker Newman Noyes have focused on the credit from the individual side, but the credit is available to either the student or an employer who makes the payments, and the primary focus here is to explain this credit from an employer’s perspective. Readers will find this article a bit technical, but it is supplemented with easy-to-follow examples, and describes an overlooked, but very potent benefit that Maine employers should strongly consider offering to their employees – one that can be offered at no cost to the employer, and potentially can put money back into the employer’s pocket.
Before the employer credit can be covered in detail, it’s worth a quick refresher of which employees are eligible for the credit in the first place. As it stands for the 2018 tax filing year, an eligible employee for the program would have to satisfy the following requirements:
- Obtained an associates or bachelor’s degree after 2007 or a graduate degree after 2015 from an accredited Maine or non-Maine community college, college or university;
- After graduation, is a Maine resident (as defined by Maine tax law in 36 M.R.S. § 5217-D(1)(H)) working in Maine.
It’s worth noting that there are fewer restrictions on degrees that qualify on the employer side of the credit than those on the individual side of the credit; individuals will run into restrictions related to non-Maine undergraduate and graduate degrees that an employer will not encounter.
One of the other concepts that needs to be understood is the status of a payment as an “eligible education loan payment.” Eligible education loan payments are payments made by an employer directly to the lender during the part of the tax year in which the eligible employee was a resident of Maine, working in Maine. Unlike the individual side of the credit, the eligible education loan payment on the employer side is not limited to a “benchmark payment amount,” but employers are still limited to the “required loan payment amount,” as amounts in excess of the lender’s required loan payment are not eligible for the credit. Payments made on refinanced or consolidated loans qualify for the credit as long as the refinanced loan remains separate from any non-educational loans.
Simple Credit Mechanics & Example
With the basics of the credit explained above, our focus will shift to the mechanical and calculation-based components, which, while complex, have been simplified (somewhat!) for purposes of this article. The first step involves computing the gross credit amount, which is the monthly eligible education loan payment multiplied by the number of payments made during the year while the employee was a Maine resident and employed in Maine. The second step calculates the modified gross credit, which equals the gross credit prorated by eligible education loan payments made by the employer relative to the combined eligible education loan payments made by the employer and employee. The third step calculates the final credit amount based on employee status (full time vs. part-time). For credit purposes, full time employees are those who work at least 32 hours a week, while part-time employees work at least 16 hours a week but less than 32 hours a week. The final credit amount is 100% of the modified gross credit for full time employees or 50% of the modified gross credit for part-time employees. Employers cannot claim the credit for employees who work less than part time.
To illustrate how an employer would calculate the credit for a single employee, consider the example of John Smith, an employee of ABC Corp, a Maine corporation. Due to difficulty recruiting new talent, ABC Corp has added student loan repayment to its employee benefit package. John’s compensation includes $500 per month to be paid by ABC Corp to help John with his student debt. John’s required payment amount is also $500 per month, but John decides to pay an additional $250 out of pocket each month. The calculations are as follows:
Step 1: Gross Credit
|Eligible Monthly Payment = $500||John has a required loan payment of $500 per month.|
|Payments During Year = 12||12 payments were made during the year by ABC Corp.|
|Gross Credit = $500 * 12 = $6,000||The monthly payment multiplied by the number of payments results in a $6,000 gross credit.|
Step 2: Modified Gross Credit
|Employer Payments = $500 * 12 = $6,000||ABC Corp. paid $500 monthly on the loans, so the total employer payments for the year are $6,000.|
|Total Payments = ($500 + $250) * 12 = $9,000||Since ABC Corp. paid $500 and John paid $250, the total payments for the year are $9,000.|
|Proration Factor = $6,000 / $9,000 = 0.6667||To determine the proration factor, you divide the employer payments by the total payments made during the year.|
|Modified Gross Credit = $6,000 * 0.6667 = $4,000||Multiplying the gross credit amount by the proration factor results in a $4,000 modified gross credit.|
Step 3: Final Credit
|Full Time Factor = 1.0||Full time employees are those that work at least 32 hours per week.|
|Part-Time Factor = 0.5||Part time employees are those that work at least 16 hours per week but less than 32 hours per week.|
|Final Credit (Full-Time) = $4,000 * 1.0 = $4,000||If John works full time, ABC’s final credit is $4,000.|
|Final Credit (Part-Time) = $4,000 * 0.5 = $2,000||If John works part time, the final credit is $2,000.|
Credit Stipulations & Reporting Requirements
To qualify for the credit, an employer’s payments must be made directly from the employer to the lender. The credit will not be available to an employer who reimburses its employee for the loan costs (although in that case, the employee may be able to claim the credit), or uses a third party vendor to administer the credit.
An employer claims the credit by completing and attaching to its Maine income tax return a schedule entitled Tax Credit Worksheet for Employers. If claiming the credit for payments made on behalf of multiple employees, the employer will have to complete and include multiple worksheets with its tax return. The credit claimed during a given tax year will equal the total credit on all the worksheets plus any prior carryforwards. For C corporations and proprietorships, the total credit amount will be entered on a single line of the Maine income tax return. For flow-through entities like S Corporations and partnerships, the reporting requirements get a bit more involved; flow-through entities complete the employer worksheets but they also include a schedule of assignment of the credit amounts to each owner that is submitted with the entity’s tax return. The flow-through entity owners, in turn, include that paperwork with their own returns, to support their shares of the credit.
Before processing the credit, Maine Revenue Services sometimes requests additional documentation, such as college transcripts, and evidence of the qualifying loans, required payment, and actual payments made during the year. While the administrative burden of offering the credit may seem like a drawback, there are some significant benefits beyond the credit amount itself that make it an attractive tool for employers.
Assuming an employer pays the eligible education loan payments in their entirety for an eligible employee, the employer will receive a dollar for dollar Maine income tax credit equal to those payments. The credit is “nonrefundable,” meaning it is capped at an amount that offsets otherwise existing Maine income tax. Any excess may be carried over for use in future years. In addition to claiming the credit, the employer will also be able to deduct the payments as compensation to the employee, which will reduce taxable income and income taxes accordingly on the federal and state level. With this increase in compensation also comes a small amount of additional payroll taxes the employer will have to pay, but those payroll taxes are also deductible for income tax purposes and are relatively insignificant compared to the overall benefit.
Let’s expand our earlier example, to show the more comprehensive nature of this credit. In this scenario, assume that ABC Corp is an S Corporation that is 100% owned and operated by Bob Williams. Bob’s income tax rates on his personal income tax return are 24% for federal and 7.15% for state. ABC Corp will pay John’s $500 monthly payment amount for 12 months (with no amounts paid by John out of pocket) and will have to pay payroll taxes on that additional compensation at the rate of 7.65%. The calculations are as follows:
|Total Payments = $500 * 12 months = $6,000
Federal Tax Rate = 24%
Maine Tax Rate = 7.15%
Payroll Tax Rate = 7.65%
|These are the relevant assumptions listed above that will be used to determine the tax and cash flow benefit of claiming the credit.|
|Total Payments = $6,000
Employer Payroll Taxes = $6,000 * 7.65% = $459
Total Outflow = $6,000 + $459 = $6,459
|The eligible payments are the first cash outflow.
The related payroll tax is the second cash outflow.
This results in the total cash outflow.
|Employer Credit = $6,000
Comp Benefit = $6,000 * (24% + 7.15%) = $1,869
Payroll Tax Benefit = $459 * (24% + 7.15%) = $143
Total Inflow = $6,000 + $1,869 + $143 = $8,012
|The credit is the first cash inflow.
The benefit of deducting the payments as additional compensation for federal and state tax purposes provides the second cash inflow.
The benefit of deducting the additional payroll taxes for federal and state tax purposes provides the third cash inflow.
This results in the total cash inflow.
|Total Outflow = $6,459
Total Inflow = $8,012
Net Inflow / (Outflow) = $8,012 - $6,459 = $1,553
Return On Dollars Spent = $1,553 / $6,459 = 24.04%
|Total outflow calculated above.
Total inflow calculated above.
The net amount will be inflow less outflow.
The end result is a profitable return for the employer.
While the example above may be simplified, it demonstrates the dramatic benefit that the credit can offer to Maine employers. This credit is an attractive option for many Maine businesses as it provides Maine employers with an avenue to offer student loan repayment as a benefit to its employees – potentially at no cost (and even at a profit).
Interestingly, it is possible for some employees to be in a better position on a net-of-tax basis if they make the loan payments themselves, with no involvement from their employers. This can occur in a couple scenarios:
- An employee who makes the loan payments may enjoy a credit of the same amount, thereby causing that employee to not be out of pocket anything at all on a net basis. However, the employee must part with the loan payments up front, each month, and will not be “made whole” until filing a tax return in April of the following year. If the employer, instead, makes the payments, the employee will make no monthly loan payments, but must report the loan payments as taxable income, and will be on the hook no later than that following April for the taxes on that “phantom income.” Employees, therefore, will need to weigh the benefit of having someone else assume immediate and monthly loan payments against the tax cost that will result.
- In situations where an employee’s credit may be partially limited (due to lack of income or other factors), it may be more beneficial (at least in the short term) for the employee to let the employer make the payments and claim the credit.
As noted earlier, employers, but not employees, can claim a credit for out-of-state education, so in those cases, the employee and the employer are both better off if the employer makes the payments. In any cases where both are eligible to receive the credit, careful analysis should be applied before choosing who should make the payments.
While there are indeed some hoops to jump through, the powerful impact this credit can have for both employers and employees can be well worth it. It’s a great planning tool for tax purposes and at the same time provides Maine employers with what can be a cost-free, or even positive cash flow vehicle, to attract talent from in or out-of-state.
For more information or to discuss how you or your business may benefit from this credit, please contact Nate Marcet or your BNN tax advisor at 800.244.7444. You can also access the 2018 Educational Opportunity Tax Credit Worksheet for Employers online here.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, investment, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.