Ms. Ortega deducted $19,885 in education expenses associated with her doctoral degree in psychology on her 2004 tax return. She claimed the expenses were deductible as a trade or business expense because she was already a mental health practitioner. The IRS denied the deduction because the doctoral degree qualified her for a new trade or business, i.e. staff psychologist. The Tax Court agreed with the IRS.
Ms. Ortega's Career and Education History
Ms. Ortega earned her masters degree in psychology from the University of Nebraska in 1996. After several years of working as a Mental Health Practitioner for the State of Nebraska, she went back to the University of Nebraska to earn a doctorate in psychology. Upon earning her doctoral degree in psychology, she moved to New York and began work as a staff psychologist for the Federal Bureau of Prisons. New York required a doctoral degree to practice psychology, therefore Ms. Ortega could not practice as a staff psychologist without it.
When are Education Expenses Deductible as Trade or Business Expenses?
The Tax Court succinctly states the law here:
Expenditures made by an individual for education are deductible as ordinary and necessary business expenses if the education maintains or improves skills required by the individual in her employment or other trade or business. Sec. 1.162-5(a), Income Tax Regs. However, the general rule under section 1.162-5(a) does not apply [and the expenses are not deductible] if the expenses fall within either of the two specified categories: (1) The expenses are incurred to meet the minimum education requirements for qualification in the taxpayer's trade or business; or (2) they qualify the taxpayer for a new trade or business. Sec. 1.162-5(b).
If the education in question qualifies the taxpayer to perform tasks and activities significantly different from those she could perform before the education, then the education is deemed to qualify the taxpayer for a new trade or business. Browne v. Commissioner, 73 T.C. 723, 726 (1980).
The mere capacity to engage in a new trade or business is sufficient to disqualify the expense for deduction. Weiszman v. Commissioner, 52 T.C. 1106, 1111 (1969).
Did Ms. Ortega's Doctoral Degree Qualify Her for a New Trade or Business?
Ms. Ortega asserts the doctoral degree did not qualify her for a new trade or business because she continued to work in the field of psychology before and after her education.
The Tax Court disagreed. State law controls the outcome here. In both Nebraska and New York, the only requirement for being a mental health practitioner was a masters degree in psychology, which Ms. Ortega already had. In contrast, both states required a doctoral degree in psychology to practice as staff psychologist. When Ms. Ortega left Nebraska and went to work in New York, she started practicing as a staff psychologist. Accordingly, "the doctorate . . . [q]ualified her to perform tasks and activities significantly different from those she could perform before the eduction." Therefore, her education expenses were not deductible as a trade or business expense.
This is not a completely straightforward area of the law, but the decision here is correct. For example, though I already practice tax law as a CPA, my law degree will qualify me to be a lawyer. Therefore, even if I never intend to practice as a lawyer, my law degree expenses are not deductible.
Finally, even if Ms. Ortega was allowed to deduct the education expenses in question, the deduction would be limited by section 67. Section 67 imposes a two-percent floor on miscellaneous itemized deductions. That is, itemized deductions, other than those listed in section 67, are deductible "only to the extent that the aggregate of such deductions exceeds 2 percent of adjusted gross income." Sec. 67(a). Adjusted gross income is defined in section 62. Alternatively, you can look at page 1 of the Form 1040 to see how to calculate AGI.