One of the trickier areas to understand is when a taxpayer may or may not claim a trade or business deduction for education related expenses. In the case of Kopaigora v. Commissioner, TC Summary Opinion 2016-35 the IRS believed the taxpayer had not incurred deductible education expenses—but the Tax Court disagreed.
While ordinary and necessary expenses related to a trade or business are generally deductible under IRC §162, education expenses pose a couple of concerns. First, they must be expenses incurred once one is actually engaged in the trade or business in question (otherwise they won’t meet the general §162 requirements) and they cannot be personal in nature (which would run afoul of the prohibition of deducting such expenses found in IRC §262).
To deal with these issues the IRS has issued regulations specifically related to education expenses as a business deduction found at Reg. §1.162-5. That regulations provides a general rule found at Reg. §1.162-5(a):
(a) General rule. Expenditures made by an individual for education (including research undertaken as part of his educational program) which are not expenditures of a type described in paragraph (b) (2) or (3) of this section are deductible as ordinary and necessary business expenses (even though the education may lead to a degree) if the education -
(1) Maintains or improves skills required by the individual in his 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.
The two “barred” type of education deductions found in §1.162-5(b)(2) and (3) cited above are those that meet the minimum education requirements for a trade or business or those that qualify the taxpayer to enter a new trade or business (whether or not the taxpayer actually enters that new trade or business).
This case involves a taxpayer who took courses that would lead to a master’s degree in business administration degree (MBA). At the time he originally enrolled in the program he was working as senior assistant controller for a hotel located near Los Angeles International Airport. The Court described his responsibilities as follows:
Petitioner’s duties included preparing financial reports, creating budgets, analyzing financial data, producing forecasts to enable reaction to business changes, and monitoring different departments’ performances. Additionally, petitioner conducted audits, prepared an accounting of taxes, prepared financial reports according to generally accepted accounting principles (GAAP), enforced internal controls, reconciled balance sheets, and ensured compliance with reporting requirements.
He originally enrolled in the MBA program to improve his leadership skills in corporate finance and management. However, in April of 2011 his employment at the hotel was terminated. While he sought employment following his termination, he did not actually obtain new employment until September of 2012, just after he received his MBA.
His new position was vice president of finance at a small financing company. The Court described his duties there as follows:
As vice president, petitioner was responsible for overseeing department managers, managing and leading a team of employees, supervising employees in daily issues of accounting, cash, risk, and business operations, and participating in hiring and training. Additionally, petitioner was responsible for auditing, accounting for taxes, setting up monthly reporting according to GAAP, and enforcing internal controls.
The IRS challenged his deduction of educational expenses on his 2011 income tax returns, putting forward three reasons for disallowance:
- He did not carry on a trade or business as he was unemployed for an indefinite period;
- The MBA degree was a general degree that did not maintain or improve the specific skills required for his trade or business; and
- The MBA degree qualified him for a new trade or business.
The Court disagreed with the IRS on all counts.
With regard to the challenge that he wasn’t carrying on a trade or business, the court noted:
...[P]etitioner’s unemployment did not prevent him from continuing his trade or business as a finance and accounting business manager for purposes of section 162. After petitioner’s employment at Marriott LAX was terminated he actively sought employment within the corporate finance and accounting field for the remainder of his time at BYU, and his active job search paid off. Soon after he graduated from the EMBA degree program, petitioner was hired by another company to perform duties that were substantially similar to the duties of his former job.
As far as the IRS’s final two complaints that the education was too general to be useful in his trade or business and that it qualified him for a new trade or business, the Court found:
When his employment was abruptly terminated, he continued to take courses at BYU that improved his managerial and leadership skills--skills that were appropriate and helpful to his position as a business manager. The courses petitioner chose to fulfill his degree requirements did not qualify him for a new trade or business because he was not qualified to perform new tasks or activities with the conferral of his degree. Instead, petitioner chose courses in a line of study that he was familiar with--management and finance. Even though petitioner took a few courses that were outside this scope, we do not believe that these courses by themselves could have prepared him to enter a new trade or business.
It is important for the reader not to read too much into this ruling, but understand that it was a fact based determination applying the general rules found in the regulations. Certainly had Mr. Kopaigora not held a position for which MBA training would be helpful before he began his degree program it would have been unlikely he would have prevailed. Similarly, the case also reminds us that a mantra mistakenly learned that you can’t claim the deduction if you obtain the degree clearly wasn’t what prevailed here—nor should it have (note the regulation specifically allows that the attainment of a degree or failure to do so isn’t what determines deductible status).
Rather each situation requires a consideration about whether the taxpayer’s education relates to an existing trade or business and whether it would qualify the taxpayer for a trade or business he/she could not otherwise enter without the education.