In January 2010, The Wall Street Journal ran a story about the fight of nurse Lori Singleton-Clarke to deduct nearly $15,000 in business school tuition as an unreimbursed employee business expense on her federal income tax return. The twist to the story, besides the fact that she represented herself in U.S. Tax Court and won (after three years of IRS discussions), is that it lays out a road map for other students in deciding whether to deduct business school expenses.
While the U.S. Tax Court issued a summary opinion in the Singleton-Clarke case, in a similar case, Daniel R. Allemeier, the Tax Court judge issued a memorandum opinion, which implies that the judge thought the case did not involve a novel legal issue and that the tax law in the area was well settled. Though tax court rulings do not create precedent that must be followed by every court, decisions like these are persuasive precedent and bode well for students in similar tax circumstances.
This was the case for alum Benjamin Post, MBA '08, who recently described his experience claiming the deductions on the mbaMission blog. "Sometime in 2006, a professional colleague forwarded me an article that was of great benefit to me and several of my MBA classmates," Post explains. "This article discusses the deductibility of MBA tuition within the context of Daniel Allemeir’s tax dispute with the IRS, and it has ended up saving me (and some of my classmates) thousands of dollars." The IRS opened an investigation into his 2007 tax return, which Post successfully defended, and his deduction was allowed.
Why Would You Want to Claim a Deduction and What is a Reimbursed Business Expense?
Tax deductions are variable amounts of tax-code-specified expenses that you can subtract, or deduct, from your gross income when you compute your income taxes. As a result, tax deductions lower your overall taxable income, thus lowering the amount of income tax you owe. The exact amount of tax savings is dependent on the tax rate (sometimes called a bracket) you are in, and if you are affected by the alternative minimum tax.
As Kristina Zvinakis, a lecturer in the Department of Accounting explains it, tax deductions are allowed only by legislative grace; nothing is deductible unless the tax code provides for such a deduction. In the area of deductions, the IRS is especially concerned about taxpayers deducting what would otherwise be personal and, as such, non-deductible expenses. This makes sense given their focus on collecting sufficient tax revenue to support the operation of the federal government.
As Zvinakis puts it, "More deductions lower taxable income, which lowers tax liability payments, which lowers the revenues that the Treasury has to operate with."
Are You Eligible to Claim This Federal Income Tax Deduction?
So let's say you are a McCombs business student. Can you take this deduction?
It varies greatly by degree type and individual circumstances. For example, since an MPA degree allows you to sit for the CPA exam, it's highly unlikely MPA students would be able to claim this deduction, as this would be a minimum qualification for their field. The same would be true for many MBAs, particularly those who are transitioning in their career or who haven't established themselves in "trade or business" prior to entering the MBA program.
As a bachelor's degree is required for entry to most fields, undergraduate BBA students would be hard pressed to be able to show that they had a current field to "maintain and improve" in or that they weren't filling a minimum requirement. Most Ph.D.s would also be unable to claim this deduction, given that a doctorate is required for most faculty posts (which would make their degree a minimum requirement), unless they happen to teach somewhere where a master's is the norm, or if they are continuing in a career in industry.
However, for many part-time MBAs, some full-time MBAs, a few isolated Ph.D.s who are working while earning a Ph.D., or for any student who is self-employed and plans to stay that way, this is a deduction to consider.
"The code tries to be specific about what types of education expenses are deductible," says Zvinakis. "If your education prepares you for a new trade or business, or if it provides you a minimum qualification, then you cannot deduct those expenses. The types of expenses that are deductible are those expenses that maintain or improve your skills or are required in your employment. In other words, this education is not preparing you for something new or different and not providing you with a minimum qualification. You are acquiring skills to make you better at the job you already have."
Zvinakis continues, "The tax law also makes clear that it doesn't matter if you don't actually go on to work in a new field. Let's say you were an English teacher and you came back for an MBA because you thought that in the future it might benefit you in higher administration, but you continue working as an English teacher. Your education costs would not be deductible in this situation. Even if you don't choose to work in that new field, if you have been prepared for a different field, education expenses will not be deductible."
In short, your education costs are deductible only if they are required for "carrying on" your current profession. So, a marketing professional taking courses related to social media marketing would likely be able to claim the deduction, but that same marketing professional doing an investment track could not.
Further, expenses should be “ordinary and necessary” to your performance in your present job. In the example of the marketing professional, even if a master's in Spanish might help you market better to certain demographics in theory, it's probably too far a leap to assume that the expenses would be considered "ordinary or necessary" for your marketing career.
What You Can Do - A Checklist
If you have gone through the above information and determined that you are/would have been eligible for the deduction, what should you do next?
1) Check your dates. The IRS allows amended returns for the past three years; make sure that your deductions are in the right time frame to still take action.
2) Make sure you have the necessary documentation. This includes tuition bills and receipts for all your purchases, as well as supplementary materials that might include, but would not be limited to, canceled checks, your resume, your job history timeline, a letter from your employer and so on.
3) Run the numbers. Just because you can claim the deduction doesn't guarantee it will lower your income tax liability. You'll need to look at your unique situation and what your particular expenses (and income) were. Keep in mind that scholarships would reduce your potential deduction. For students who already didn't owe taxes (perhaps due to a lack of income during their degree years), your benefit from taking a deduction might be minimal or non-existent.
4) If you are a current or prospective student, consider your tax planning options. For example, if you will be eligible for this deduction, and you are entering a two-year program that spreads out costs over three fiscal years, you might consider prepaying some spring or second-year expenses (as you are able) in the fall of your first year so that your deduction is bigger in the year your income is also bigger (and so on). You'll also want to come up with a system to organize and store your paperwork and receipts for when you should need them.
5) Consider your state. Though Texas does not have a state income tax, many states do. Make sure you consider how your state tax bill might have been affected, as well.
Taking it to (Tax) Court
So you have determined you should qualify for the deduction and save quite a bit of money off your tax bill. Great! Keep in mind that the IRS might not agree. If you are notified by the IRS of an audit, don't freak out. (After all, if you on the right side of the law and have done everything in good faith, and have the records to prove it, you have nothing to fear.) Instead, consider your options.
"It is not perfectly clear, which is why I think you see people in court," says Zvinakis. "Fundamentally, whether you are qualified for a new trade or business is a 'facts and circumstances' test. Your analysis of the facts and circumstances may different substantially from the IRS's analysis."
Keep in mind also that even if you are claiming completely valid deductions, many others are not, and so part of the IRS's duty is to investigate unusually large deductions, relative to income. They aren't after you, after all, they are after tax cheats.