What are the basics of educational benefit trusts?

An educational benefit trust (EBT) is a trust arrangement that allows an employer to accumulate funds to pay educational expenses for its employees' children. If carefully structured, an employer's EBT can provide the employer with current tax deductions for contributions to the trust. At the same time, an EBT can defer tax on the educational benefits provided to employees' children until benefits are actually paid out.

However, if an EBT is not structured properly, an employer may find that it has given up control of the money used to fund the trust without being able to take a deduction until years later when the benefits are paid.

Trust instrument. Typically, an EBT is set up by establishing a trust and appointing a trustee. The trust instrument should contain instructions on the following topics:

• Investments. What discretion should the trustee have in investing the funds of the trust? May the trustee act independently or at the direction of the employer, or just with the employer's approval?

• Benefits. Who is entitled to benefits under the trust? Children of key employees? Children of all employees? Are only college expenses covered or do benefits extend to graduate school, technical school, or self study? What fees are paid-just tuition, or are books and fees also paid for? How much will the benefits be? Will the benefits be in the form of grants or loans or a combination of the two?

• Termination of employment. What happens to benefits for the children of employees who have terminated their employment or who have died?

• Excess funds. If the trust accumulates more funds than it needs for benefits, what happens to the excess money?

• Changes in the program. Can the employer amend the trust or terminate it? Will changes affect all benefits or only those accrued after the date of the change?

The answers to these questions can determine whether an EBT receives favorable tax treatment.