The Tax Law Report

Education Expense as Trade or Business Deductions: Part Two

Shah v. Commissioner, T.C. Summ. Op. 2010-6 (2010).

Question for the Tax Court

May a taxpayer deduct education expenses as trade or business expenses when the education expenses directly related to the taxpayer's existing trade or business, but were part of a program of study that led to a new trade or business?

Background

During the years at issue, 2005 and 2006, Mr. Shah was an undergraduate student at New York University (NYU), where he majored in film and television studies. (3).  To meet his graduation requirements he was required to complete both the core courses of his major and elective courses from other fields of study. (3).  A substantial number of the elective courses . . . were in computer science, web design, and multimedia. (3).

While attending high school in Chicago, IL, Mr. Shah began performing information technology services for clients of his Dad's business. (3).  Part of the work involved working on websites for these clients. (4).  He earned between $5,000 and $10,000 during 2003 and 2004 providing these services. (3).

After graduating from NYU, he began working in the entertainment industry . . . creating multimedia content for his employer's website. (4).

On his 2005 and 2006 tax return, Mr. Shah deducted the costs of the classes he took at NYU that related to his trade or business as a website designer while in high school. (8).

When are Education Expenses Deductible as a Trade or Business Expense?

The Tax Court does not recite the applicable regulations in their opinion, but they are helpful for the analysis so I have provided them below.

Regulation 1.162-5(a) states in part:  [e]xpenditures made by an individual for education . . . 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 applicable law or regulations, imposed as a condition to the retention by the individual of an established employment relationship, status, or rate of compensation.

Exceptions to the General Rule

Regulation 1.162-5(b)(2) states in part:  The first category of nondeductible educational expenses . . . are expenditures made by an individual for education which is required . . . to meet the minimum educational requirements for qualification in his employment or other trade or business.

Regulation 1.162-5(b)(3) states in part:  The second category of nondeductible education expenses . . . are expenditures made by an individual for education which is part of a program of study being pursued by him which will lead to qualifying him in a new trade or business.

Argument Made by Taxpayer

Petitioner maintains that he deducted only tuition and book costs for those classes related to his computer work.  (7).  Specifically, petitioner posits that since he was employed in Web design and multimedia while in high school, classes he took at NYU related to those fields should be considered to be qualifying work-related education that improved skills and not a program of study that qualifies him for a new trade or business. (8).

Tax Court's Holding

While his computer and Web design courses may have improved his skills, they also helped qualify petitioner for a new trade or business. (8).  These courses were necessary for him to earn his bachelor's degree since he could not have graduate from NYU without those credits. (8).  Therefore, these courses were part of a course of study that will lead to qualifying petitioner in a new trade or business. (8).  As we stated in Warren v. Commissioner, supra:  "what is important under the regulations is that the degree 'will lead' petitioner to qualify for a new trade or business. (8) citations omitted.  Consequently, we hold that petitioner may not deduct his tuition and book expenses for 2005 and 2006. (8).

Blog Comments

The Court reached the right conclusion, but for the wrong reason.

The Court concludes that Mr. Shah's bachelor's degree qualifies him for a new trade or business different from his web design trade or business, but they don't say what that new trade or business is.  In reaching this conclusion, the Court places emphasis on the fact that Mr. Shah could not graduate NYU without the credits in website design and multimedia classes.  I suppose the inference we are meant to draw from this point is that education leading to a bachelor's degree in XYZ implicitly qualifies the taxpayer for a new trade or business.

However, this ignores the first sentence in the regulation that allows a deduction for education expenses "even though the education may lead to a degree."  Based on the first sentence of the regulations, it would seem irrelevant then that the credits in web design and multimedia classes were required to graduate from NYU.  In fact, if this were the standard, almost every type of secondary education expense would be nondeductible as trade or business expenses.

The Court should have placed their emphasis on the type of bachelor's degree Mr. Shah was pursuing, "film and television studies."  The Court then could reasonably hold that "film and television studies" qualified Mr. Shah for a trade or business different from web design, namely "film and television."  Mr. Shah points out, however, that he only deducted the courses that specifically related to his web design trade or business.  But the Tax Court correctly responds that the regulations exclude education expenses that are "part of a program of study that qualifies him for a new trade or business."  Mr. Shah's web design classes were "part of a program of study".

Separately, the Court might have focused on the first category of nondeductible education expenses, those that "meet the minimum requirements of his employment or other trade or business."  Presumably, Mr. Shah's bachelor's degree "meets the minimum requirements of . . . [an] other trade or business."

Education Expenses: Is Your MBA Deductible?

Singleton-Clarke v. Commissioner, T.C. Summ. Op. 2009-182 (2009).

This is a long post because the decision will have some widespread implications, even though it is a tax court summary opinion, which is by definition of no precedential value.

Question for the Tax Court

Is a registered nurse working in an administrative role in the healthcare industry entitled to deduct the costs of an MBA with a focus in healthcare management, or does the MBA qualify her for a new trade or business, thus not deductible?

Background

Petitioner, Ms. Singleton-Clarke, is a registered nurse (RN) with 24 years experience.  From 2004 to 2007 she worked for Civista Medical Center.  (3).  Her job title was quality improvement coordinator and her responsibilities were to coordinate the quality improvement and risk management activities for the hospital. (3).  The minimum education and experience requirements were 'a Bachelor of Science degree in Nursing or equivalent education and experience' . . . and 'current licensed as a RN . . . .' (4).

From 2007 to 2008 she worked for Children's National Medical Center in Washington, D.C.  (4).  Her job requirements stated:  'Bachelor's in Nursing; Master's in Public Health preferred.  Two years quality improvement experience in a hospital setting . . . . ' (4).

In late 2008, she began working at St. Mary's Hospital.  Her title is performance management coordinator, and . . . her duties focus on coordinating, planning, and implementing the Hospital's performance improvement activities.  The job qualifications are:  RN license required.  B.S. Health Care Administration required--Masters preferred.

Petitioner began taking courses at the University of Phoenix in March 2005, graduating in April 2008 with an MBA/HCM.  (5).  The MBA/HCM provides students 'with the business management skills needed to manage successfully in today's health care delivery systems.'  The program features courses in 'health care organizations, health care finance, quality and database management, health care infrastructure, and health care strategic management.'

Ms. Singleton-Clarke paid the entire cost of the program and none of her employers had a reimbursement policy for the MBA/HCM program.  Ms. Singleton-Clarke deducted $14,787 in unreimbursed employee business expenses for education expenses.  The IRS disallowed the entire amount.

When Are Education Expenses Deductible?

Section 1.162-5, Income Tax Regs., Expenses for Education (the regulation), interpreting section 162, Trade or Business Expenses, governs whether a taxpayer may deduct education expenses.  The regulation provides that a taxpayer may deduct education expenses as ordinary and necessary business expenses

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.

Sec. 1.162-5(a)(1) and (2), Income Tax Regs.

Conversely, the regulation provides that if the education qualifies the individual for a new trade or business, then the education expenses are not deductible because the education is a personal expense or constitutes an accumulation of personal capital. Sec. 1.162-5(b)(3), Income Tax Regs.

Whether the education qualifies the taxpayer for a new trade or business is an objective inquiry analyzing the tasks and activities the taxpayer was able to perform before the education in comparison to those the taxpayer was qualified to perform afterward. (citations omitted). In other words, the relevant standard is whether the education objectively qualifies the taxpayer for a new trade or business. (citations omitted).  Accordingly, the taxpayer's subjective intent in undertaking the education is not relevant, and likewise it is not material whether the taxpayer does in fact become employed in a new trade or business. (citations omitted).

IRS's First Contention:  The MBA/HCM was a prerequisite to the St. Mary's job

The IRS contends that without receiving the MBA/HCM in April 2008 petitioner would not have obtained her final job, the one she started in September 2008 at St. Mary's, because the St. Mary's job description . . . required at least a bachelor of science in health care administration, which petitioner had not previously earned.

Tax Court's Answer: No.

We believe that St. Mary's would have gladly hired petitioner . . . even without the MBA/HCM.  All three positions, [prior to her St. Mary's position], required an RN license or a bachelor's in nursing, with clinical or risk management experience; credential the petitioner possessed. (10).

[W]e find that the MBA/HCM may have been a helpful addition to her qualifications, but was not an essential prerequisite for petitioner to secure the position at St. Mary's. 

IRS's Second Contention:  The MBA qualifies petitioner for a new trade or business

The IRS contends that the MBA/HCM does qualify petitioner for a new trade or business, because in respondent's words, under the regulation 'the tasks and activities she was qualified for before she obtained the degree are different than those which she is qualified to perform afterwards'.

Tax Court's Answer:  The MBA does not qualify petitioner for a new trade or business

An MBA degree is different from a degree that serves as foundational qualifications to attain a professional license.  For instance, this Court had denied deductions for law school expenses, because a law degree qualifies a taxpayer for the new trade or business of being a lawyer. (11).

An MBA is a more general course of study that does not lead to a professional license or certification. (11).

This Court has had differing outcomes when deciding whether a taxpayer may deduct education expenses related to pursuing an MBA, depending on the facts and circumstances of each case. (12).

Analyzing petitioner's situation, her facts and circumstances far more closely resemble the cases that allowed a deduction for pursuing an MBA.  Petitioner worked for 1 year as a quality control coordinator and had more than 20 years of directly related work experience, gaining vast clinical and managerial knowledge in acute and subacute health care settings, before beginning the University of Phoenix MBA/HCM program. (15).

[T]he MBA/HCM may have improved petitioner's preexisting skill set, but objectively, she was already performing the tasks and activities of her trade or business before commencing the MBA. (16).

Blog Comments

I think the Tax Court missed the mark here.  They do a wonderful job of articulating the law but then drop the ball when applying the facts to the law.  Its analysis regarding whether an MBA qualifies the taxpayer for a new trade or business is overly generous, and is almost certain to allow any taxpayer with even remote ties to any sort of existing trade or business a free ride on the Fisc's shoulders for an MBA. 

A walk through the regulations will help highlight my point.  The regulations lay out a test that has two prongs, both of which must be satisfied before education expenses are deductible. 

The first prong can be satisfied in one of two ways: either by showing that the MBA "improves existing skills required by the employer or trade or business" OR by showing that the MBA "is required condition of retaining the current job".  Here, Ms. Clarke's MBA was not a condition to her keeping her job, thus she had to show that the MBA improves the skills required by her current job, namely "coordinating, planning, and implementing the Hospital's performance improvement activities."  No big disagreement here, an MBA improves this required skill.

The second prong is always the more difficult prong for taxpayers to pass.  The second prong requires a showing that the MBA does not qualify you for a new trade or business.  It does not matter whether the taxpayer actually takes a job in a new trade or business, it only matters that the taxpayer is now qualified to do something different.  A key question is whether the taxpayer's current trade or business should be considered in determining if the education qualifies the taxpayer for a "new" trade or business.  Based on examples provided in the IRS regulations, I think the answer is yes.  How do you know if the taxpayer is qualified to do something "new" without comparing a "hypothetical new trade or business" to the "old trade or business"?

Here, Ms. Clarke's "old" trade or business is in the field of healthcare management.  Now that she has an MBA, is she qualified to leave healthcare management and go work in a different industry? This is where the Tax Court's analysis completely breaks down.  The Court considers an MBA, "a general course of study" that may or may not qualify the taxpayer for a new trade or business depending on the facts and circumstances.  It might be helpful to know that all MBA's from accredited institutions require 2/3 of the studies to be in various areas of accounting, marketing, operations management, etc.  The other 1/3 can focus in concentrations or other areas of study.  Ms. Clarke's MBA/HCM from the University of Phoenix is no different.  36-54 credit hours must be in required courses of study such as accounting, marketing, business law, management, economics, etc.  After which, 15 credits can be taken in areas of study/concentration such as Health Care Management.

I find it extremely unreasonable to conclude that this course of study does not qualify Ms. Clarke to leave the field of healthcare management and pursue any myriad of job opportunities in other industries with her new MBA.  I would conclude that she is absolutely qualified to "perform tasks and activities different" from those she was qualified to do before her MBA.  To conclude otherwise ignores the fact that 2/3 of her course of study were not relevant to her existing position.