Taxability of Dependent Tuition Benefits

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Tuition Benefits for dependent children can be taxable at the federal and/or state level, depending upon a number of factors.

Federal taxability of undergraduate dependent child tuition benefits is determined by whether or not your child meets one of two Federal Definitions of Dependency which is assessed in the same way regardless of whether or not your child is using the benefit to attend Penn, or using it at another school.

State taxability of dependent child tuition benefits is determined both by your state of residence and whether your child is using the benefit at Penn or at another school.

The following offers more information on taxability at the federal and state levels for dependent tuition benefits. The details provided here are intended to help clarify, not supersede, information in the official tuition benefit policies 407 and 408. Nor does it affect any agreements made by the employee with the Division of Human Resources through tuition benefit payment requests in the Online Tuition Benefit Management System. It’s important to also review the official policies before using the benefit at hr.upenn.edu/PennHR/benefits-pay/tuition/. Benefits are subject to change as are regulations governing the taxability of tuition benefits.

Taxability information:

  • Federal taxability information for undergraduate dependent child tuition benefits
  • State tax liability information for undergraduate dependent child tuition benefits
  • Federal and state tax liability for graduate dependent tuition benefits (benefit offered to grandfathered employees only meeting specific policy criteria)

Federal Taxability at the Undergraduate Level

Under current federal law, undergraduate tuition benefits are generally not subject to federal withholding as long as the faculty/staff member’s dependent meets one of the two federal definitions of Dependent Children outlined below (unless the tuition benefit provided is on behalf of the un-adopted biological child of a same-sex domestic partner). In many to most cases, the traditional student will meet the first definition and the dependent undergraduate tuition benefit will be non-taxable. You are asked, however, to review these definitions and indicate whether or not your child meets one of the two definitions every time you make a request for payment.

You should be aware that changes in federal tax law can change the taxable nature of undergraduate tuition benefits for some children. If your dependent child does not meet one of the two federal tax law definitions described below, the tuition benefits received will be taxable to you as additional income. (Note that benefits provided on behalf of the child of a same-sex domestic partner will be taxable unless you have adopted the child. This is true even if you can claim the child as a dependent on your federal income tax return.) 

As part of the tuition benefit application process, you are asked to declare if your child meets one of the two federal definitions of a dependent (summarized below) each time you request payment of the benefit.

Federal Definitions of Dependent Children

Your dependent children eligible to receive tuition benefits include a "qualifying child" or a "qualifying relative" under applicable federal law.

A "qualifying child" is a child who:

  • is your biological child, adopted child or stepchild;
  • lives with you for more than one-half of the year;
  • has not attained age 19 as of the close of the year or has not attained age 24 as of the close of the year if the child was a full-time student for at least five months of the year (Note: These age limits do not apply in the case of a child who is permanently and totally disabled); and
  • does not provide over one-half of his or her own support for the year.

A "qualifying relative" is a child who: 

  • is your biological child, adopted child or stepchild;
  • receives over one-half of his/her support for the year from you (subject to a special rule in situations where a child's support is provided by two or more individuals);
  • does not have gross income in excess of a specified amount ($3,650 for 2010, but not including certain income earned by a disabled individual at a sheltered workshop); and
  • is not a qualifying child (as defined above) of you or any other taxpayer for the year.

For purposes of any requirement above that a child live in your household, temporary absences due to special circumstances, including absences due to illness, education, business, vacation or military service are not treated as absences. Special rules apply in the case of parents who are divorced or legally separated. The IRS provides additional information for special circumstances such as split custody in a divorce in their guidelines under the sections “Qualifying Relative” or “Qualifying Child” in IRS Publication 501. For questions beyond what the IRS provides, please contact your tax advisor for more information.  

If you indicate in your tuition benefit payment request that your child does meet one of those two definitions, your benefit will not be treated as federal taxable income. If you indicate your child does not meet either definition, then your benefit must be treated as taxable to you at the federal level.

If the benefit is taxable to you at the federal level, we are required to pay the taxes on your behalf. The method we use to do this will depend upon whether your dependent child is using the benefit to attend Penn or using the benefit at a school other than Penn.                       

Federal Tax Withholding - Dependents Attending Penn

If your dependent child is using the benefit at Penn to pursue their Bachelor’s degree and does not meet either of the two Federal Definitions of Dependent Children, your benefit will be treated as taxable income. In this case, the appropriate taxes are withheld directly from the benefit and the net amount is awarded to the student as the tuition benefit. In other words, the Tuition Benefit Office will report the amount of tuition benefit you receive for any terms within a calendar year (January to December) on your W2 as income for that calendar year (simply added to your personal salary). It will also withhold roughly 36% to 40% from the benefit payment your dependent will receive to cover the taxes on your behalf. This deduction from your child’s benefit amount will be re-routed to be paid as taxes and will show up on your W2 in the various “taxes paid” boxes.

Penn is paying the taxes from the benefit, offering a loan that you “pay back” by paying the balance on your dependent’s student account. The gross tuition amount and taxes withheld are reported to the IRS as a part of your earnings. You as the taxpayer are responsible for making appropriate payroll withholding adjustments, if desired, and for settling your tax liability on year-end tax filing. The income and taxes paid are recorded for the calendar year in which the term(s) reside for which you received the benefit (regardless of the date you actually received the benefit payment). 

Federal Tax Withholding - Dependents Attending A School Other Than Penn

If your dependent child is using the benefit at a school other than Penn to pursue an undergraduate degree and does not meet one of the two Federal Definitions of Dependent Children, your benefit will be treated as taxable income. In this case, the tuition benefit for which you are eligible will be processed through a direct pay to you as the employee. This means, the appropriate tuition benefit amount will be determined based upon Penn’s tuition benefit policies outlined in Policy 408 and the calculated benefit, less applicable taxes, will be paid directly to you, the employee. You are then responsible for providing a receipt to the Tuition Benefit Office showing the payment to the school.

The gross tuition amount and taxes withheld are reported to the IRS as a part of your earnings. You as the taxpayer are responsible for making appropriate payroll withholding adjustments, if desired, and for settling your tax liability on year-end tax filing.

State Taxability

If you reside in the state of New Jersey, your dependent tuition benefit is considered taxable income to you at the state level. Regardless of whether or not your dependent meets one of the two federal definitions of dependency (which determines whether you can receive a non-taxable benefit at the federal level), tuition benefits for residents of New Jersey are considered taxable income at the state level. The Tuition Benefit Office will handle the withholding differently depending upon whether or not your child is attending Penn or another approved school for their education.

State Taxability – Dependent Child Is Attending Penn

If your dependent child is using the benefit at Penn to pursue their Bachelor’s degree and your benefit is taxable income at the state level, then the appropriate state tax is withheld directly from the benefit and the net amount is awarded to the student as the tuition benefit. The state tax withholding is calculated using a pre-determined standard state tax rate for the state. In other words, Tuition Benefit Office will report the amount of tuition benefit you receive for any terms within a calendar year (January to December) on your W2 as state income for that calendar year (simply added to your personal salary). It will also withhold the appropriate state tax from your tuition benefit payment to cover the tax on your behalf. This deduction from your child’s benefit amount will be re-routed to be paid as tax and will show up on your W2 in the state “tax paid” box.

Penn is paying the taxes from the benefit, offering a loan that you “pay back” by paying the balance on your dependent’s student account. The gross tuition amount and tax withheld are reported to the IRS as a part of your earnings. You as the taxpayer are responsible for making appropriate payroll withholding adjustments, if desired, and for settling your tax liability on year-end tax filing. The income and taxes paid are recorded for the calendar year in which the term(s) reside for which you received the benefit (regardless of the date payment was received).

State Taxability – Dependent Child Is Attending A School Other Than Penn

The Tuition Benefit office will calculate the state tax withholding for any benefit taxable at the state level using a pre-determined standard state tax rate for the state. This will be a set percentage of the amount of the benefit your child (or children) receives for the semester. The Tuition Benefit Office pays that state tax withholding amount on your behalf, which serves as a loan to you, the employee which you will “pay back” through payroll deductions. Towards the end of the semester or after the semester end, the Tuition Benefit Office will then deduct the amount originally paid as state tax on your behalf, from your weekly or monthly pay over a pre-determined number of pay periods. You as the employee will have indicated in the tuition benefit request process whether you wanted to have the amount withheld in one lump sum, or incrementally over several pay periods (three pay periods for monthly paid employees or twelve pay periods for weekly paid staff).

Taxability of Dependent Graduate Tuition Benefits

Graduate tuition benefits may be available to employees who were grandfathered under a prior plan because they were in an eligible position at the University prior to June 30, 1997. Eligibility for this benefit would also require that the dependent child meets Penn’s definition of dependency and the dependent child attends Penn for graduate education. If you believe you may meet these requirements, you can contact the Tuition Benefit Office for confirmation of eligibility and more information on how the taxability of graduate tuition benefits are managed. The Federal Definitions of Dependency are not applicable at the graduate level. Graduate tuition benefits for dependent children of faculty and staff are subject to federal income tax, FICA (Social Security tax), Medicare tax and city wage tax from the first dollar and, if the employee is a New Jersey resident, to state tax. Please contact the Tuition Benefit Office for more information.