Case — Employee Business Expenses – Tuition

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TL Case Summ

THE QUESTION

Can a taxpayer deduct tuition for a master of business administration program?

THE DISPUTE

Taxpayer Says: He was in the business of selling pharmaceuticals and the MBA classes enabled him to obtain employment and are deductible.

Internal Revenue Service Says: Taxpayer was not established in a trade or business and his employers did not require him to enroll in an MBA program. The tuition expenses are not deductible.

THE LAW

From Internal Revenue Code Section 162(a): Provides a deduction for “all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.”

From Internal Revenue Code Section 67(a): Miscellaneous itemized deductions, such as the deduction for unreimbursed employee business expenses, are allowed only to the extent that the total of such deductions exceeds 2% of AGI.

From Internal Revenue Code Section 262(a) : Disallows deductions for personal, living, or family expenses.

From Federal Tax Regulation 1.162-5(a): Provides that a taxpayer may deduct
educational expenses as ordinary and necessary business expenses if the education (1) maintains or improves skills required by the individual in his or her employment or other trade or business or (2) meets the express requirements of the individual’s employer, or the requirements of applicable law or regulations, imposed as a condition to the retention by the individual of an established employment relationship, status, or rate of compensation.

From Federal Tax Regulation 1.162-5(b)(3)(i): Education expenses, however, are not deductible as ordinary and necessary business expenses if the education is part of a program of study being pursued by a taxpayer that leads to the taxpayer’s qualifying for a new trade or business.

From Deputy v. du Pont, 308 U.S. 488, 495 (1940): A trade or business expense is ordinary for purposes of section 162 if it is normal or customary within a particular trade, business, or industry, and a trade or business expense is necessary if it is appropriate and helpful for the development of the business.

From Orvis v. Commissioner, 788 F.2d 1406, 1408 (9th Cir. 1986), aff’g T.C. Memo. 1984-533: For such expenses to be deductible, the taxpayer must not have the right to obtain reimbursement from his or her employer.

From Link v. Commissioner, 90 T.C. 460, 463 (1988), aff’d without published opinion, 869 F.2d 1491 (6th Cir. 1989): Implicit in both section 162 and the regulations is that the taxpayer must be established in a trade or business before any expenses are deductible.

THE CAUSE OF THE DISPUTE

In general, you can deduct ordinary and necessary expenses incurred while carrying on your trade or business. Your performance of services as an employee constitutes a trade or business, and expenses you pay for education can be deductible if they maintain or improve skills you need for your job or the education is a condition of your employment.

Because the deciding factors can vary depending on your situation, education expenses related to graduate degrees are a frequent area of dispute. Taxing Lessons has covered similar cases before, here and here. A handy, non-authoritative graphic is available in IRS publication 970 here.

In this case, the taxpayer graduated from college two years before starting the MBA program. At the time of his enrollment, he was employed as an oncology account specialist (specializing in the sale of cancer pharmaceuticals). He alternated between periods of unemployment and working at a similar occupation for three separate companies during the year at issue (2009).

On his 2009 federal income tax return, the taxpayer deducted $17,138 as unreimbursed employee business expenses for MBA program tuition. He contends he was in the business of selling pharmaceuticals and that the MBA classes he took enabled him to obtain employment in 2009.

The IRS says the taxpayer was not established in a trade or business before entering the MBA program, and his employers did not require him to enroll in an MBA program. Therefore, the tuition expenses are not deductible.

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HL Carpenter, an experienced investor and a CPA, specializes in reader friendly articles on taxes and investing for individuals and small businesses, and publishes two newsletters: Taxing Lessons and Top Drawer Ink. Visit TaxingLessons.com and HLCarpenter.com.

This information should not be considered legal, investment or tax advice. Taxing Lessons and Top Drawer Ink Corp. do not provide legal, investment or tax advice. Always consult your legal, investment and/or tax advisor regarding your personal situation.

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Sorry, wrong answer :(
Right answer!
For the IRS. The taxpayer was not established in a trade or business before enrolling in the MBA program, and therefore, his expenses are not deductible. We do not doubt the taxpayer was qualified to engage in a trade or business selling pharmaceuticals. Qualification, however, is not the same as “carrying on” a trade or business. The taxpayer’s employment in the cancer pharmaceutical sales field was not continuous, and there is no evidence in the record that he was carrying on a trade or business before he enrolled in the MBA program.
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