This is for anyone that took an extension on their 2020 taxes while struggling to figure out what to do with the Section 127 Exemption. After waiting for over an hour and a half and on a call with the IRS agent for almost two hours, this is what I was advised if you are self-employed. This note does not address Section 127 exemptions for any business entity. First, look at Pub 15-b. The Pub 15-b for 2021 (https://www.irs.gov/publications/p15b#en_US_2021_publink[phone number removed]) fixes the confusion by specifically covering sole proprietors. It also covers some partners, so check out the publication.
First you have to adhere to the requirements, i.e. meet the definition, write out an educational assistance plan, etc. Second, Section 127 is an exemption, i.e. the specified amount of wages are not taxed and thus not counted on your taxes as income. It is NOT a deduction. You do not write off the $5,200 loan payment as an educational or business expense. Instead, you deduct the amount of student loans paid, up to $5,200 to the extent you still have income. This can be tricky with issued 1099s which will reflect a different amount. Thus, I was advised to document the deduction. I'd say it's a good idea to document the payments as coming from the business account, whether to the lender directly each month or to yourself for payment if you have a separate business account and transfer funds into a personal account. The last part is just my personal thoughts to demonstrate transparency should an issue arise. If you qualify and take the student interest deduction, you can only deduct the principal under Section 127.
If you have a business where you are paying educational assistance to employees, as a sole proprietor, you would deduct those funds as expenses under the employee benefit item on the Schedule C - I looked it up and believe it's line 14.
As I said above, this is for self-employment and sole proprietors only. I am not a tax professional and I cannot state that the advice I was provided by the IRS in accurate or complete or that I accurately understood and communicated what was explained to me. Take the above information at your own risk. I am merely passing along the information it took me months to obtain. Good luck!
