Does Education Maintain    Or Improve   Job Skills That Are Needed?

Earning an MBA: How to Pass the Tax Law Test

In climbing the corporate ladder, many business people find that it's in their best interests to go back to school to obtain an MBA or other graduate degree. In some cases, companies may agree to pick up some or all of the tab. Otherwise, these taxpayers have to pay for the higher education themselves.     That raises an interesting question: Can they write off the costs associated with advanced degree studies? It is sometimes possible but difficult.      The IRS often challenges deductions for business education that would otherwise be deductible because the courses qualify the taxpayer for a new trade or business. More often than not, the courts have sided with the IRS, but each case is decided on its own merits.     One example: A salesman for a sports medicine product was assigned additional responsibilities related to marketing. After his supervisor speculated that an advanced degree in marketing would help him get ahead in the company, the taxpayer enrolled in an MBA program. Subsequently, the taxpayer was promoted to a higher position. He deducted the cost of the MBA program on his personal return.     The IRS denied the taxpayer's deductions because it said that the MBA qualified him for a new job. However, in this instance, the Tax Court allowed the deductions. Reason: The degree wasn't required for the job, but it "improved preexisting skills" the taxpayer used before enrolling in the MBA program, the court stated. In addition, the taxpayer already had work experience related to marketing, so the education did not prepare him for a new line of work. (Allemeier, TC Memo 2005-207)     The decision in this case shows that in certain situations, write-offs can be secured when obtaining an advanced degree.     Another example: In this case, the taxpayer wasn't as fortunate. The Tax Court ruled that Tracy McEuen wasn't eligible to deduct just over $20,000 in expenses to earn an MBA. Reason: The degree qualified her to work in a new field and was a requirement for the job she previously held. (McEuen, TC Summary Opinion 2004-107)     If you are in the process of getting an advanced degree, or planning to go back to school, consult with your tax professional about the specifics of your expenses.     What happens if an employer pays for graduate school courses or provides tuition reimbursements? The payments are generally tax-free to the employee whether or not the courses qualify him or her for a new trade or business. In addition, the employer can deduct the full amount of the payments made to the employee or the school.

For example, let's say you are planning to take a course at a local college to brush up on your computer skills or begin a curriculum designed to take you to the next level in your profession. Can you write off the cost of business education on your personal tax return? The answer is "it depends."

Explanation: Basically, the tax law says that you can write off the cost of business education that either:

1. Is required by your employer or by law to keep your current job.

2. Maintains or improves the job skills needed in your present work.

Education that maintains or improves your skills in your present job may include refresher courses, courses on current developments or other academic or vocational courses. It doesn't matter if the coursework leads to an advanced degree such as an MBA. You deduct the costs as miscellaneous itemized expenses, which are subject to limits described below.

On the other hand, even if the business education meets one of the two tests above, you're not allowed to take a deduction if the education:

1. Is needed to meet the minimum educational requirements of your current job or

2. Is part of a program that qualifies you for a new trade or business.

So keeping the above rules in mind, you could take deductions for a computer refresher course. But you could not claim write-offs for courses needed to fulfill the minimum education requirements for your job or those that enable you to qualify for a new career.

As you might imagine, the lines in this area can become quite blurred, and therefore, this matter is often contested in the courts. The IRS often prevails in such cases, especially if the issue turns on whether or not the education qualifies the taxpayer for a new career.

There are no limits on business education deductions for self‑employed individuals. However, employees must claim unreimbursed business education costs as miscellaneous expenses on their tax returns and they can be difficult to deduct because many taxpayers do not have enough of them to realize any benefit.

Taxpayers can only deduct the annual miscellaneous expenses in excess of 2 percent of adjusted gross income (AGI). For example, say that a taxpayer's AGI for 2007 will be $80,000 and it costs $3,000 to attend school part‑time. If the taxpayer has no other miscellaneous expenses for the year, he or she can write off $1,400 ($3,000 minus 2 percent of $80,000).

What About Employer-Paid Education?

A taxpayer can avoid the 2 percent-of-AGI limit if he or she is fortunate enough to be reimbursed for expenses by an employer. In that case, the employee doesn't have to report the reimbursements to the IRS (but he or she can't claim any deductions either). To qualify for this tax break, an employee must properly account to an employer for all expenses.

Alternatively, if a company maintains an educational assistance plan, employees may be able to receive up to $5,250 in annual tax‑free education benefits. For this purpose, the courses do not have to improve or maintain job‑related skills. They can lead to a new job, help you meet minimum requirements or just be educational in nature.

Companies can generally deduct the cost of courses or seminars that employees attend to maintain  professional or job-related skills. But the write-off isn't limited to tuition. It also covers items such as books, supplies and certain travel costs. (There are some limits for company owners on deducting the cost of education that is not related to the job.)

Important: Don't confuse the tax rules for business education deductions with other education tax breaks. If you meet certain requirements, you may qualify for generous tax credits (such as the Hope or Lifetime Learning Credits) or an above-the-line tuition deduction. Planning to take courses in the future? Keep in mind that adults can also open up Section 529 plans (also called Qualified Tuition Programs) and make themselves the beneficiaries. But that's another tax lesson for a different time!

Ask your tax adviser for the best way to proceed in your situation.