A special tax rule allows an employee to exclude from gross taxable income on his/her tax return and from wages for employment tax purposes up to $5,250 annually paid by his or her employer for educational assistance. 

Only reimbursements for undergraduate-level course work qualify for the educational assistance exclusion from your tax return.  

This tax law allows the employer to deduct on it's tax return the cost of these educational assistance benefits and does not require you to treat the payments as taxable income on your tax return.

With higher education costs climbing steadily upward nearly 8% per year many families are particularly concerned about accumulating enough money to put their children through college. College cost projections are continually increasing. Based on the latest averages from The College Board and recent average annual college cost increases, a child who entered kindergarten in 1995 will face four-year college costs of nearly $100,000 if he or she chooses to attend a public college in 2007. For a private college, costs will probably be double that.

The tax law provides an option to save for college expenses - the "Coverdell Education Savings Account". While not technically an individual retirement account, the tax law allows families to contribute up to $2000 per tax year for each child under age 18 into these tax favored savings plans.
The beneficiary must be a child under age 18.

Anyone, including parents, grandparents, other family members and friends, and the child/beneficiary can make non tax deductible total Coverdell Education Savings Account contributions per child of up to $2000 each tax year provided the contributors Modified Adjusted Gross Income is not more than $110,000 ($220,000 on a joint tax return). There is a phase out between $95,000 and $110,000 (between $190,000 and $220,000 on a joint tax return). No contributions can be made in a tax year when any amount is contributed to a qualified state tuition program.

Earnings in the Coverdell Education Savings Account are tax free until withdrawn. Qualified education expenses are:

The child/beneficiary is not taxed on withdrawals to pay qualified higher education expenses. 

If the balance of the Coverdell Education Savings Account isn't used by the time the student reaches age 30, it must be withdrawn, or "distributed." At this point, the funds would be taxed and subject to a 10% tax penalty. This can be avoided if the balance is rolled over to another Coverdell Education Savings Account benefiting another family member, such as a younger sister or brother.
There is a 10% tax penalty on any taxable distributions from a Coverdell Education Savings Account. The tax penalty does not apply if the Coverdell Education Savings Account distribution is due to:

• death;
• disability;
• because the beneficiary received a tax free scholarship on an educational assistance allowance;
• Coverdell Education Savings Account

If tax free treatment for any part of a Coverdell Education Savings Account withdrawal is not waived no HOPE Tax Credit or Lifetime Learning Tax Credit can be taken for that tax year on your tax return. If either the Lifetime Learning Tax Credit or the education income tax exclusion for withdrawals from a Coverdell Education Savings Account is elected, the HOPE Tax Credit may not be taken on your tax return. The education income exclusion is not available in any tax year that a HOPE Tax Credit or Lifetime Learning Tax Credit is elected on your tax return with respect to a student.

Report Coverdell Education Savings Account withdrawals on Form 8606.