CRS REPORT ADDRESSES TAX INCENTIVES TO TRAIN WORK FORCE.

                            Nonna A. Noto

Under the individual income tax, a taxpayer may deduct expenses for training if they qualify under the tax provisions as educational expenses. Educational expenses may be deducted if the education is required by the employer, by law, by regulations, or if the employee uses the education to maintain or improve his work skills. Educational expenses are not deductible by the taxpayer if such education is needed to meet the minimum educational requirements for qualification in the trade or business, or can qualify the taxpayer for a new trade or business. Educational expenses used to prepare the taxpayer to return to work or to re-enter a previous business or profession are also not deductible. Thus, the deduction for educational expenses is not geared toward retraining. With the passage of the Tax Reform Act of 1986 (P.L. 99-514), these educational expenses must now be itemized together with other miscellaneous deductions, subject to a floor of two percent of adjusted gross income. This act also provided that educational travel was no longer to be allowable as a itemized deduction.

For a business, training and retraining expenses are deductible as either in-house training or outside educational assistance. In- house training expenses could be subsumed under salaries and equipment expenses or could be accounted for as payments to contractors. Outside educational assistance is likely to be accounted for under employee benefits expenses.

Certain benefit payments to participants in retraining and welfare programs and work-training programs are not included in the gross income of recipients, as defined for tax purposes.

The targeted jobs tax credit is intended to promote the creation of jobs in the private sector for specifically designated, hard-to- employ groups. The tax credit is available to employers who hire members of nine targeted groups which are believed to have educational deficiencies that hamper their members' employment prospects and require that they receive more than the average amount of training once employed.

Individual taxpayers may exclude from gross income employer payments for educational assistance. The annual limit for excluded employer payments is $5,250. The exclusion is not limited to education that is needed for one's current trade or business, as is the case with permitted educational expense deductions; consequently, it could apply to training for a new job or career.

TABLE OF CONTENTS

TRADE OR BUSINESS EXPENSES (SECTION 162)

DEFINITION OF GROSS INCOME (SECTION 61)

Training and retraining programs

Work-training program

TARGETED JOBS TAX CREDIT (SECT10N 51)

EMPLOYER EDUCATIONAL ASSISTANCE (SECTION 127)

TAX INCENTIVES TO TRAIN OR RETRAIN THE WORK FORCE

According to the Department of Labor, the U.S. economy is expected to create almost 25 million additional jobs during the fifteen-year period between 1990 and 2005. This projected average job growth rate of 1.2 percent is approximately one-half the average job growth rate of 2.3 percent for the preceding fifteen-year period of 1975-1990. ¹ Many of the fastest growing occupations and those occupations in which the largest number of jobs are projected to be created require education or training beyond the high school level. Indeed, two out of three of the thirty fastest growing occupations and nearly half of the thirty occupations with the greatest number of job openings had a majority of workers with education or training beyond the high school level in 1990. ²

While there is a projected overall increase in total domestic employment opportunities, displaced workers may not have the necessary skills and work experience to qualify for new job opportunities. Both technological change and foreign competition have resulted in displacement of labor in certain occupations and industries. For example, technological change from the introduction of computers has led to job losses in some occupations. Other workers, such as those in the steel industry, have actually lost jobs due to foreign competition or have had future jobs foreclosed as industries have restructured and streamlined to become more competitive. Even after individuals have found employment retraining and skill building opportunities still may be needed or required.

High school dropouts are disadvantaged in the job market and have less opportunity for job advancement than those who obtain a high school education. More than half who left high school before completion were employed as operators, fabricators, or laborers, that is, unskilled or semi-skilled blue-collar occupations, or in service occupations. Workers in these occupational groups have below-average weekly earnings. In addition, few high school dropouts were employed as managers, professionals, or technicians, resulting in the conclusion that the labor market advantages of at least finishing high school are clear. ³

Various legislative proposals have been suggested in recent Congresses to help train prospective employees for jobs or retrain current employees for more skilled jobs. These proposals are based upon the belief that human resources are no less important to the economy and welfare of the Nation than the updating of business plant and equipment. Programs that provide training are seen as one method to help solve unemployment problems.

This report details information about provisions of the Internal Revenue Code related to training or retraining. While all these provisions are currently available, the employer educational assistance provision and the targeted jobs tax credit are both scheduled to expire on June 30, 1992. Internal Revenue Code (I.R.C.) section numbers are provided (in parentheses) from the I.R.C. of 1986.

TRADE OR BUSINESS EXPENSES (SECTION 162)

Educational expenses may be deducted either by the taxpayer or by a business firm.

Under the individual income tax, expenses for training made by the employee (himself or herself) may be deductible if they qualify under the provisions for employee educational expenses. Your Federal Income Tax, Publication 17, of the Internal Revenue Service states:

"REQUIREMENTS. The education must:

1) Be required by your employer or the law to keep your salary, status, or job (and serve a business purpose of your employer), or

2) Maintain or improve skills required in your present work." ⁴

There are two conditions under which a taxpayer may not claim a deduction for such educational expenses:

"Even if your education meets one of the requirements listed above, it is not qualifying education if it:

1) Is needed to meet the minimum educational requirements of your present trade or business, or

2) Is part of a program of study that can qualify you for a new trade or business, even if you have no plans to enter that trade or business.

PRESENT WORK. Your education must relate to your present work. Education that will relate to work you may enter in the future is not qualifying education. Education that prepares you for a future occupation includes any education that keeps you up-to- date for a return to work or that qualifies you to reenter a job you had in the past." ⁵

THUS, THE EDUCATIONAL EXPENSES DEDUCTION FOR THE INDIVIDUAL IS NOT GEARED TOWARD RETRAINING.

The educational expense deduction may only be claimed by taxpayers who itemize their deductions, who tend to be higher income taxpayers. In addition, with the passage of the Tax Reform Act of 1986 (P.L. 99-514), these educational expenses must now be itemized together with other miscellaneous deductions, subject to a floor of two percent of adjusted gross income. Simply stated, only when educational expenses combined with other deductible miscellaneous deductions exceed two percent of adjusted gross income may the portion that exceeds the two percent floor be deducted. Thus, the floor negates the benefit of the deduction for many taxpayers.

The Tax Reform Act of 1986 also provided that educational travel was no longer to be allowable as an itemized deduction. The Conference Report states: "No deduction is allowed for costs of travel that would be deductible only on the grounds that the travel itself constitutes a form of education (e.g., where a teacher of French travels to France to maintain general familiarity with the French language and culture, or where a social studies teacher travels to another State to learn about or photograph its people, customs, geography, etc.)." ⁶

For a business, training and retraining expenses may be deductible as either in-house training or outside educational assistance. On a business tax return, in-house training expenses could be subsumed under salaries and equipment expenses or could be accounted for as payments to contractors. Outside educational assistance is likely to be accounted for under employee benefits expenses.

DEFINITION OF GROSS INCOME (SECTION 61)

As defined for tax purposes, certain benefit payments to participants in training and retraining programs and work-training programs are not included in the gross income of recipients. Simply stated, payments are exempt from income taxation. Under generally accepted principles of taxation, such benefit payments would be treated as income and taxable to the recipient. Thus, the exclusion of these benefit payments from individual income taxation provides a tax incentive effect for such training, retraining, and work-training programs.

Reproduced below are portions of paragraphs 631.1742 and 644.2737 under the definition of gross income presented in the Commerce Clearing House's (CCH), Standard Federal Tax Reports. Please note that these citations are from a loose-leaf service subject to constant revision and are presented as they appeared as of the date of this report.

(CCH PARAGRAPH 5504.1742)

TRAINING AND RETRAINING PROGRAMS -- Benefit payments made to individuals undergoing training or retraining under either the Area Redevelopment Act or the Manpower Development and Training Act of 1962 are not includible in the gross incomes of the recipients. Rev. Rul. 63-136, 1963-2 CB 19, distinguished by Rev. Rul. 74-413.

However, where the overriding purpose of the program is to provide participants with compensation for services and not to provide them with training or retraining, the payments are includible in the participants' gross income under section 61 of the Code and subject to income tax withholding. But the participants are employees of the State excepted from employment for purposes of the FICA and FUTA. Rev. Rul. 74-413, 1974-2 CB 333, distinguishing Rev. Rul. 63-136, 1963-2 CB 19.

Payments from funds provided under both Title II-A of the Economic Opportunity Act of 1964 and the Manpower Development and Training Act of 1962 to unemployed and underemployed residents of an Indian reservation who participate in a training program to acquire skills in the construction trade are not compensation for services includible in the gross incomes of the enrollees. Rev. Rul. 68-38, 1968-1 CB 446.

And payments to school dropouts and unemployed individuals under a state "job service corps" program were characterized as employment relief payments and were not includible in gross income. Rev. Rul. 68-133, 1968-1 CB 36.

Payments made by a State welfare agency to participants in work training programs under Title V of the Economic Opportunity Act of 1964 are not includible in gross income. Rev. Rul. 71-425, 1971-2 CB 76, modifying Rev. Rul. 67-144, 1967-1 CB 12.

Stipends paid by a city to probationers under a project intended to aid them in acquiring training in skills providing opportunities for gainful employment are not includible in income. Rev. Rul. 72-340, 1972-2 CB 31.

AN EXCEPTION UNDER TRAINING AND RETRAINING PROGRAMS

Payments made by the Department of Transportation to or on behalf of individuals removed from their positions as air traffic controllers, for expenses incurred in their training for other employment, are not scholarships, fellowship grants, or governmental welfare type payments and are includible in the individuals' gross income and constitute wages under section 3401 of the Code. Rev. Rul 75-32, 1975-1 CB 14.

In contrast, many of the examples related to work-training programs give rise to taxable income.

(CCH Paragraph 5507.2737)

WORK-TRAINING PROGRAM. -- Amounts received by enrollees under work-training programs under Economic Opportunity Act of 1964 are taxable as compensation for services, no matter who employs the enrollee. Rev. Rul. 65-139, 1965-1 CB 31, as clarified by Rev. Rul. 66-240, 1966-2 CB 19.

The value of transportation furnished a Job Corps enrollee by the United States upon completion of his training is taxable. Rev. Rul. 70-198, 1970-1 CB 12.

Enrollees in the Job Corps (under the Comprehensive Employment and Training Act of 1973) are deemed employees of the United States for purposes of the Internal Revenue Code and Title II of the Social Security Act. Sec. 416. Comprehensive Employment and Training Act of 1973 (P.L. 93-203).

Payments received by a trainee, in a program under titles I and II of the Comprehensive Employment and Training Act, for services performed during on-the-job training for a private construction company or for work experience in a city clinic are includible in gross income; however, allowances received for participation in a program, or to enable the trainee to participate, and not for the performance of services are excludable from gross income. Rev. Rul. 75-246, 1975-1 CB 24.

The Internal Revenue Service scholarship program is a work- study program for internal revenue agent trainees that usually selects disadvantaged high school seniors who intend to major in accounting at a college or university and who agree to work for the Service for at least two years after graduation. The amounts the Service pays for the educational expenses of the participants in the program, including travel and per diem, are not excludable from the gross incomes either as unemployment benefits or as scholarships or fellowship grants. Rev. Rul 76-230, 1976-1 CB 19.

TARGETED JOBS TAX CREDIT (SECTION 51) ⁷

SPECIAL NOTE: THIS PROVISION IS SCHEDULED TO EXPIRE AFTER JUNE 30, 1992.

The targeted jobs tax credit is intended to promote the creation of jobs in the private sector for specifically designated, hard-to- employ groups. The tax credit is available to employers who hire members of nine targeted groups which are believed to have educational deficiencies that hamper their members' employment prospects and require that they receive more than the average amount of training once employed. In order for an employer to receive the tax credit, the employer need only hire the worker -- the provision of training is not required. The targeted groups are vocational rehabilitation referrals, economically disadvantaged youth, economically disadvantaged Vietnam-era veterans, SSI recipients, AFDC recipients or WIN registrants, general assistance recipients, economically disadvantaged youth (16-19 years old) participating in cooperative education programs, economically disadvantaged ex- offenders, ⁸ and economically disadvantaged youth (18-22 years old) hired for summer jobs.

The credit is equal to 40 percent of the first $6,000 of qualified first-year wages for all target group members except summer youth, for whom it is 40 percent of $3,000. The amount of the company's deduction for wages is reduced dollar for dollar by the amount of the credit. In order to qualify for the credit the employer must retain these employees for a minimum of 90 days or 120 hours of service, except for summer youth hires whose minimum retention period is 14 days or 20 hours.

The targeted jobs tax credit was created with the passage of the Revenue Act of 1978 (P.L. 95-600), effective through the end of 1981. The provision was both amended and extended for one year by the Economic Recovery Tax Act of 1981 (P.L. 97-34). An extension for two additional years (through 1984) and the establishment of a special credit for creation of summer jobs for economically disadvantaged 16- and 17-year-olds was provided under provisions of the Tax Equity and Fiscal Responsibility Act of 1982 (P.L. 97-248). A one-year extension was provided by the Deficit Reduction Act of 1984 (P.L. 98-369). The Tax Reform Act of 1986 (P.L. 99-514) reauthorized the credit retroactively to December 31, 1985, and extended it for three years (through December 31, 1988). Again, with passage of the Technical and Miscellaneous Revenue Act of 1988 (P.L. 100-647), the credit was extended, this time for a one-year period which expired on December 31, 1989. With the passage of the Revenue Reconciliation Act of 1989 (P.L. 101-239) the provision was extended through September 30, 1990. Once again the program was extended, this time through December 31, 1991, by the passage of the Omnibus Budget Reconciliation Act of 1990 (P.L. 101-508). In order to prevent the program from expiring the Congress passed the Tax Extension Act of 1991 (P.L. 102-227) which continued this and a number of other expiring provisions until June 30, 1992. This extension was to permit time to study the possibility of making this tax provision along with a number of other such tax provisions permanent.

EMPLOYER EDUCATIONAL ASSISTANCE (SECTION 127) ⁹

SPECIAL NOTE: THIS PROVISION IS SCHEDULED TO EXPIRE AFTER JUNE 30, 1992.

Under a normative income tax, employer payments for educational assistance should be treated as income and taxable to the recipient. Thus, like the excluded benefit payments from gross income discussed earlier under I.R.C. section 61, the exclusion of these benefit payments from individual income taxation provides a tax incentive effect for such employer educational assistance payments.

Individual taxpayers may exclude from gross income employer payments for educational assistance which encompasses tuition, fees, books, supplies, etc. The annual limit for excluded employer payments is $5,250. The exclusion is not limited to education that is needed for one's current trade or business, as is the case with educational expense deductions permitted under sec. 162 (discussed previously); consequently, it could apply to training for a new job or career.

Beginning in 1991, the exclusion amount may apply to payment for graduate level courses taken by an individual pursuing a program leading to a law, business, medical, or similar advanced academic or professional degree. Under Internal Revenue Code section 117(d) the preceding prohibition does not apply to graduate teaching or research assistants who receive tuition reduction. Courses involving sports, games, or hobbies may be covered only if they involve the employer's business or are part of a degree program. ¹⁰

Section 127 was first added to the Internal Revenue Code with the passage of the Revenue Act of 1978 (P.L. 95-600), effective through the end of 1983. The provision was extended from the end of 1983 through 1985 by Education Assistance Programs (P.L. 98-611). The Tax Reform Act of 1986 (P.L. 99-514) raised the maximum excludable assistance from $5,000 to $5,250 and extended it through 1987. The Technical and Miscellaneous Revenue Act of 1988 (P.L. 100-647) reauthorized the exclusion retroactively to January 1, 1988, and extended it until December 31, 1988. The Revenue Reconciliation Act of 1989 (P.L. 101-239) again reauthorized the provision retroactively to January 1, 1989 and extended it through September 30, 1990. With the passage of the Revenue Reconciliation Act of 1990 (P.L. 101-239), the provision was extended through December 31, 1991. The tax writing committees indicated a desire to study a number of tax provisions that have been extended a number of times in prior years. Accordingly, this provision, along with a number of others (see targeted jobs tax credit), was extended for six months (through June 30, 1992) by the Tax Extension Act of 1991 (P.L. 102-227) in order to provide the Congress with time to fashion a longer term solution.

² Silvestri, George and John Lukasiewicz. Occupational Employment Projections. Monthly Labor Review, v. 114, Nov. 1991. p. 82.

³ Ibid. p. 93.

⁴ U.S. Department of the Treasury, Internal Revenue Service. Your Federal Income Tax for Individuals, For Use in Preparing 1991 Returns. Publication 17 Washington, U.S. Govt. Print. Off., 1991. p. 168.

⁵ Ibid.

⁶ U.S. Congress. House of Representatives. Tax Reform Act of 1986. Conference Report to Accompany H.R. 3838, Washington, U.S. Govt. Print. Off., 1986. p. 30.

⁷ U.S. Library of Congress. Congressional Research Service. Targeted Jobs Tax Credit: Action in the 102d Congress. Issue Brief No. IB92007, by Linda Levine, (continually updated). Washington, 1992. 8 p.

⁸ The Revenue Reconciliation Act of 1990 clarified that an individual is to be treated as convicted if a State court places him or her on probation without making a finding of guilty.

⁹ U.S. Library of Congress. Congressional Research Service. Employer Education Assistance: Current Tax Status any Reauthorization Issues. Report 90-195 EPW, by Bob Lyke, April 10, 1990. Washington, 1990. 17 p.

¹⁰ Commerce Clearing House, Inc. 1992 United States Master Tax Guide. Chicago, Commerce Clearing House, 1991. p. 229.