Tax-Free Student Loan Repayment: $5,250 Cap and Plan Rules

An employer can pay up to $5,250 per calendar year toward your student loans without that money counting as taxable wages, as long as the payments run through a written educational assistance program under Internal Revenue Code Section 127.¹ That is the core of tax-free student loan repayment by an employer: the money skips federal income tax withholding, Social Security tax, and Medicare tax, and the employer still deducts it as an ordinary business expense. Congress recently made this treatment permanent after years of temporary extensions, and the cap will begin adjusting for inflation in 2026.

The $5,250 Annual Cap

$5,250 is the ceiling, and it is a combined ceiling. Everything the employer provides through the same Section 127 plan counts against it: tuition reimbursement, fees, books, and student loan payments all draw from the same bucket. Pay $3,000 toward an employee’s loans and only $2,250 of tax-free tuition help remains for the rest of the year.

The limit runs on the calendar year, not a plan year or fiscal year. Employers have to track cumulative benefits per employee across the year so a mid-year payment doesn’t accidentally push someone over the line and turn part of the benefit into taxable wages.

Starting with the 2026 tax year, the $5,250 figure adjusts annually for inflation. The IRS has not yet published the 2026 number, so the base amount still applies until it does.

What Loan Payments Qualify

The exclusion covers payments toward both principal and interest on a qualified education loan.² A qualified loan is one the employee took out solely to pay for their own higher education at an eligible institution. Loans taken out for a spouse’s or dependent’s education do not qualify, even if the employee is now making the payments.

The employer can send the money straight to the loan servicer or reimburse the employee.¹ When reimbursement runs through the employee, hold on to loan statements showing the amount and date, because the employee has to be able to show the funds went to a qualifying loan.

The Written Plan Requirement

None of the tax benefits apply unless the employer has a formal written educational assistance plan in place before any payments are made. Without that document, every dollar is taxable compensation.¹ The IRS publishes a sample document in Publication 5993 that employers can adapt.³

The plan has to cover several specific items:

Who is eligible. The plan defines the covered group, which can include current employees and may extend to retired, disabled, or laid-off workers.
What the plan pays for. Tuition, student loan payments, or both, spelled out explicitly.
The annual dollar limit and what happens above it.
A prohibition on cash alternatives. Employees cannot be given a choice between the educational benefit and taxable pay.¹
Reasonable notice to all eligible employees about the program’s availability and terms.

The plan does not have to be prefunded. The employer can commit to making payments as they come up without setting aside money in a trust, which keeps setup costs low enough for small employers to run the program.

Nondiscrimination Rules

A Section 127 plan cannot disproportionately favor highly compensated employees. The IRS tests this two ways.²

For 2026, an employee is highly compensated if they earned more than $160,000 from the employer in the prior year or owned more than 5% of the business at any point during the current or prior year.⁴ Eligibility rules, whether built around job title, department, or tenure, cannot filter out most rank-and-file workers while letting executives through.

Separately, no more than 5% of the total educational assistance dollars paid in a year can go to the group of employees (and their spouses or dependents) who each own more than 5% of the company.¹ This concentration test keeps owner-operators from running a plan that mostly benefits themselves.

If a plan fails either test, the tax exclusion disappears for everyone covered by it, and all payments become taxable compensation retroactively.

What Happens Above the Cap

Any employer contribution above $5,250 in a calendar year is treated as regular wages the moment it crosses the line. The excess is subject to federal income tax withholding, Social Security tax, and Medicare tax.²

On the W-2, the tax-free portion stays out of Boxes 1, 3, and 5. The taxable excess goes into those boxes as wages. Some employers also note the total educational assistance figure in Box 14 for informational purposes, though Box 14 doesn’t change the tax calculation.

Effect on Your Student Loan Interest Deduction

Employees who pay student loan interest can normally deduct up to $2,500 of that interest on their personal return under Section 221. The catch: you cannot deduct interest that was already excluded from your income under Section 127.⁵ The IRS treats using both as double-dipping.

If your employer paid $5,250 that covered a mix of principal and interest, your Section 221 deduction applies only to interest you paid out of pocket beyond what the employer covered. Someone receiving $5,250 from an employer who also pays $3,000 in interest personally can only deduct the share of that $3,000 the employer’s payment didn’t already handle. You and your preparer need to know how much of the employer’s contribution went to interest versus principal, which is another reason to save detailed loan statements.

The Section 221 deduction also phases out at higher incomes, so some employees cannot claim it at all. For them, the Section 127 exclusion is the only federal tax break available on their loan costs.

Pairing This With a 401(k) Student Loan Match

Section 127 isn’t the only option. Under Section 110 of the SECURE 2.0 Act, employers can make matching contributions to a 401(k), 403(b), SIMPLE IRA, or governmental 457(b) based on an employee’s own student loan payments, effective for plan years beginning after December 31, 2023.⁶ An employee who puts $500 a month toward loans but can’t afford to also fund a 401(k) can still get the employer match as if they were making elective deferrals. The employee certifies the loan payments annually, and the employer deposits the match. The match rate and vesting schedule have to be the same as what regular 401(k) deferrals get.

The two benefits stack. An employer can pay $5,250 tax-free toward loans under Section 127 and separately match the employee’s own loan payments into a retirement account under SECURE 2.0. One reduces the loan balance directly; the other builds retirement savings the employee would otherwise skip while paying down debt.

1
Office of the Law Revision Counsel. 26 U.S. Code 127 – Educational Assistance Programs
2
Internal Revenue Service. Frequently Asked Questions About Educational Assistance Programs
3
Internal Revenue Service. Sample Educational Assistance Program
4
Internal Revenue Service. 2026 Amounts Relating to Retirement Plans and IRAs, as Adjusted for Changes in Cost-of-Living
5
Office of the Law Revision Counsel. 26 U.S. Code 221 – Interest on Education Loans
6
Internal Revenue Service. Guidance Under Section 110 of the SECURE 2.0 Act With Respect to Student Loan Payments