Advanced degrees are being obtained by a higher percentage of the middle- and upper-class population than ever before. Many of these students hold full-time jobs. The recent development of online universities has only served to fuel this trend. The ability of working students to take a business expense deduction for tuition expenses likewise has grown in importance.With MBAs being one of the hot degrees to have as of late, because of its apparent ticket to success in many different business settings, it's a small wonder that a recent Tax Court decision has attracted more than its share of attention. That case (Allemeier Jr., T.C. Memo. 2005-207) appears to have opened up the possibility that the expense for obtaining a larger number of MBA degrees can be written off as a trade or business expense.
Before counting on the deduction to lower after-tax tuition costs, however, a careful look at the circumstances addressed by the Tax Court is important. Extension of this good news to other academic programs also deserves investigation. Finally, comparison-shopping in considering alternative routes to the same end - a tax benefit from tuition payments - is worth a look.
MBA tuition expenses
The Tax Court in Allemeier permitted a sales manager to deduct the expenses of his MBA program despite his concurrent advancement through his company.
After three years of rapid promotions in a sports medicine business, the salesperson-turned-manager decided to enroll in an MBA program at the encouragement of his supervisor. While he was not required to obtain the degree to keep his job, his boss speculated that the taxpayer would advance more quickly with an MBA degree. The company did not reimburse any tuition payments. The taxpayer deducted tuition expenses for the MBA program as an itemized miscellaneous expense. The Tax Court allowed the deduction, reversing the Internal Revenue Service's disallowance on audit.
Generally, educational expenses are not deductible business expenses under Code Section 162(a), if the degree sought is a minimum educational requirement for the individual's employment or if it prepares the individual for a new trade or business. If the tuition expense is not within these two prohibited circumstances, Reg. Sec. 1. 162-5 requires that they must be tested further and pass one of two conditions before being allowed as a deduction:
* The education must maintain or improve skills required by the individual in his employment or other trade or business; or,
* The education must meet express education requirements imposed by the employer to keep a job.
The Tax Court in Allemeier introduced a concept that has yet to be fully developed - that of considering a promotion as a new trade or business or at least as a position that may require more formal education. In the "up or out" culture of many offices, this appears to be an important development.
The Tax Court ultimately decided that having the taxpayer's boss encourage him to obtain an MBA and speculating that it might help him advance through the company did not amount to a requirement that the taxpayer get an MBA as a condition of being promoted.
Nor did the fact that the taxpayer actually advanced while he progressed through his MBA program establish the degree as a minimum requirement for his promotions. The court clearly implied that finding either one of those circumstances to exist would have been fatal to the taxpayer's deduction.
Education undertaken to meet an employer's minimum educational requirements is considered a personal, non-business expense. The recent Tax Court case introduces the novel and somewhat slippery concept of educational requirements being a moving target when viewed from the perspective of qualifying for promotions. Getting another degree to enhance job performance may be the unwritten rule in many offices, especially those in metropolitan areas with access to a variety of programs.
In larger organizations where promotions are more structured, the concept of minimum educational requirements for certain job levels may take on a reality different from than examined by the Tax Court. What if a position level carries with it alternative minimum job requirements - say, five years of experience or two years of experience plus an MBA degree?
On the one hand, someone with the higher level of experience who takes an MBA degree program may have an easier time proving same-trade-or-business because of the variable educational requirement. On the other hand, someone not anywhere close to qualifying using the years-of-experience criteria alone may find it difficult to rebut the inference that obtaining an MBA would qualify her for a new business by meeting the minimum educational criteria.
New trade or business
In Allemeier, the Tax Court held that the MBA degree did not prepare the taxpayer for a new trade or business, since he was already performing managerial and financial tasks before he entered the program. The MBA may have sped his way up the corporate ladder, but it did not change the basic nature of his duties.
Although a degree that qualifies an individual for a professional certification or license (such as a law degree) may prepare one for a new trade or business even though the individual had previously been performing essentially the same tasks, an MBA is different in that it does not qualify one for a professional certification or license.
An MBA in many respects triggers the same analysis as an advanced law degree in tax: It is useful in many business situations. The end result of this analysis, however, is usually different, with the MBA degree more likely to be considered a deductible business expense.
The recent Tax Court case clearly treats an advanced business degree as offering considerably greater secondary benefit to a wider variety of job situations than, say, a Master of Laws in Taxation degree. In cases involving the advanced tax degree, the courts generally have sided with the IRS in holding that the generic advantage to knowing tax law common to attorneys, accountants and asset managers is not a sufficient reason to group those tax professionals into a single category of trade or business. Courts have recognized the separateness of these trades or businesses, "even though the lines of demarcation may become somewhat blurred" (Hudgens, III, T.C. Memo. 1997-33).
Likewise, while an examination of the duties of any particular job is useful in determining whether a new trade or business exists, showing overlapping duties is not dispositive. If significant differences also exist, the job that fits the degree will be considered a new trade or business for purposes of making tuition a personal expense.
While an examination of general job classifications forms a critical part of the analysis of determining whether tuition qualifies as a business expense deduction, examination of the particular job duties of the particular taxpayer in question must be performed as an additional step once the job classification test is passed. If substantial differences exist in the tasks and activities of the employments undertaken before and after the education, then each employment constitutes a separate trade or business.
For education that opens up a license to practice in a profession (law, medicine or engineering, for example), the difficulties of proving same-trade-or-business generally are insurmountable. An MBA degree, however, opens up no such licensing opportunity.
Nevertheless, courts in the case of MBAs do look into the particular work done by the taxpayer and the nature of the coursework taken to receive the MBA. Specialty MBAs, for example, in "finance," "accounting" or "taxation" have a bearing on whether the degree is intended to prepare the holder to undertake a new trade or business.
The Hope Education Tax Credit is only allowed for a college degree, and a college degree almost universally is considered to prepare a taxpayer for a new trade or business. The Lifetime Learning Credit, however, often holds trade or business tuition as a subset of expenses that qualify for the credit. The credit is available up to $2,000 each year or 20 percent of expenses, whichever is lesser, but carrying an adjusted gross income limit of a relatively low $43,000 (or $87,000 for joint filers) before phase-out (as inflation-adjusted for 2005).
Alternatively, individuals may also take an above-the-line deduction for qualified tuition and related expenses. This deduction maxes out at $4,000 in 2005 for taxpayers with AGIs not exceeding $65,000 ($130,000 for joint filers). Expenses used for the credit or as a business deduction cannot be counted for another tax break. Most significantly, it is scheduled to expire at the end of 2005, unless extended by Congress.
Since the taxpayer in Allemeier was already engaged in managerial tasks, the court considered those skills that he developed through the MBA program as merely "enhancing and maintaining" the skills he already had, and did not qualify as a new or different trade.
Variations in required or developed skill sets, however, deserve careful consideration. Drafting of formal job descriptions might keep this use in mind. Equally critical because of Allemeier is consideration of how new job titles given in promotions may impact the employee's chances for a business expense deduction.
Allemeier also shows that an employer may be in somewhat of an awkward position if it does not offer a tuition reimbursement program, yet insists that employees go for advanced degrees.
Nevertheless, even when marketplace conditions might allow such an approach, the employer should definitely consider leaving the requirement at "strong encouragement" rather than something mandatory. That will allow the employee at least the partial after-tax benefit of a miscellaneous itemized deduction.
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