The Tax Law Report

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.

Taxpayer Discarded Day Planner, Mileage Deduction Denied

Menzies v. Commissioner, T.C. Summ. Op. 2009-196 (2009).

Question for the Tax Court

May Mr. Menzies deduct unreimbursed employer expenses for business use of his personal vehicle even though he discarded the day planner that he recorded his mileage in?

Background

Mr. Menzies held two jobs during 2005 interspersed with two periods of unemployment.  (2).  During the first half of 2005, he worked as a fire restoration field technician. (2).  During the second half of 2005, he worked as a field operations supervisor for a security company. (2).  Both jobs required Mr. Menzies to use his personal vehicle to travel during the day to various jobsites. (3).

The taxpayer deducted $18,649 in unreimbursed employee business expenses on schedule A of his 2005 tax return. (4).  The expenses consisted of $12,249 for business use of his personal vehicle, $400 for travel, and $6,000 for other miscellaneous unreimbursed employee business expenses. (4).

The IRS disallowed the taxpayer's entire deduction for lack of substantiation. (5).

Law for Unreimbursed Employee Business Expenses

Section 162(a) allows a deduction for ordinary and necessary expenses incurred during the taxable year in carrying on a trade or business. (6).  Generally, the performance of services as an employee constitutes a trade or business.  Primuth v. Commissioner, 54 T.C. 374, 377 (1970). (6).  For such expenses to be deductible, the taxpayer must not have received reimbursement and must not have the right to obtain reimbursement from his employer.  See Orvis v. Commissioner, 788 F.2d 1406, 1408 (9th Cir. 1986), affg. T.C. Memo. 1984-533. (6).

If a taxpayer establishes than an expense is deductible but is unable to substantiate the precise amount, the Court may estimate the amount, bearing heavily against the taxpayer whose inexactitude is of his own making.  Cohan v. Commissioner, 39 F.2d 540, 543-44 (2d Cir. 1930) (the Cohan rule or simply Cohan). (6).

Section 274(d), however, supersedes the Cohan rule with regard to certain expense.  Section 274(d) requires stricter substantiation for . . . travel, meals, and listed property such as personal automobiles. (7).

Answer from the Tax Court: no record, no deduction

[Here], the taxpayer calculated the amount of the deduction ($12,249) by multiplying the business mileage by the standard mileage rates in effect during 2005. (8).  Each workday, the taxpayer recorded the mileage from his first worksite to the last worksite of the day in a "day planner". (8).  He noted all the sites he visited during the day; however, he did not record the mileage between sites. (8).

Mr. Menzies testified that he discarded his day planner in 2007, sometime after filing his 2006 return and receiving his refund, because he felt the documentation was no longer necessary. (8).  He was therefore unable to produce any records to substantiate the business mileage, and, further, he did not attempt to reconstruct a record of his business mileage. (8).

The Court believes Mr. Menzies incurred unreimbursed vehicle expense related to his work . . . during 2005.  However, the Court may not estimate vehicle expenses under Cohan.  Therefore, we must sustain the IRS's determination. (9).

NOTE:  The Court also sustained the IRS's determination with respect to the $400 in travel expenses, but did allow 50% of Mr. Menzies' $6,000 in other miscellaneous unreimbursed items; subject to the 2% floor of course.  I think they felt sorry for him!

Blog Comments

Ouch! This was a very harsh lesson for the taxpayer.  Taxpayer's should keep records supporting the amounts on their tax returns for at least three years.  The IRS makes this very clear on page 91 of the Form 1040 instructions.  Of course, I am sure taxpayers thoroughly read the Form 1040 instructions before preparing their tax returns, all 174 pages!

Having read several tax court opinions over the last six months, it has become very apparent that the IRS's "go to" argument against taxpayers is lack of substantiation for their deductions.  Given the importance of record keeping, the three-year guidance should be front and center on the instructions to every tax form, not buried 91 pages into a 174 page document.

Moreover, Mr. Menzies claimed his unreimbursed employee business expenses on Form 2106-EZ.  The instructions for this form do not even mention the three-year record keeping requirement, only that records must be kept.  As applied here, Mr. Menzies did keep records, he just did not keep them long enough.

Unreimbursed Employee Business Expenses

Foriest v. Comm’r, T.C. Summary Opinion 2009-110 (T.C. 2009).

Mr. Foriest is a firefighter and an alleged farmer (during 2003 he was also the owner of a lawn care business). The IRS disallowed, among other things, his unreimbursed employee business expense deductions (except the union dues), and his farming loss deductions on his 2003 and 2004 tax returns.

Unreimbursed Employee Business Expenses

In total, Mr. Foriest claimed a $4,024 deduction for unreimbursed employee business expenses on Form 2106, Employee Business Expenses. This amount included:

1. $2,040 in contributions to a common meal fund for meals consumed at the firehouse.
2. $1,514 in 2003 and $1,580 in 2004 for uniform cleaning and maintenance.
3. $260 for incidental business expenses for both 2003 and 2004.
4. $210 for union dues in 2003, and $510 for union dues in 2004

Section 162(a) allows a deduction for trade or business expenses that are ordinary and necessary. Section 6001 requires taxpayers to keep records that substantiate expenses were paid or incurred during the year they take the deduction. Section 262(a), however, disallows personal living expenses. Here, Mr. Foriest failed to adequately substantiate his incidental business expenses because he provided no documentation supporting the $260. Neither could Mr. Foriest provide documentation supporting more than $260 in union dues. Consequently, the Court reduced his deductions to an amount he could substantiate.

Meal Expenses are generally not deductible unless incurred while traveling on business away from home. see section 262(a). The Court points out, however, that where a firefighter is required as a condition of employment to contribute to a common meal fund, then those contributions qualify as deductible ordinary and necessary business expenses. But, if a firefighter voluntarily contributes, then the contribution is considered a non-deductible personal expense. Here, Mr. Foriest voluntarily contributed to the common meal fund, consequently his meal expenses are non-deductible personal expenses.

Uniforms are deductible if (1) required as condition of employment and (2) not adaptable for everyday use. While the Tax Court agrees that Mr. Foriest is required to wear a uniform as a condition of employment, he did not provide any documentation to substantiate his claimed expenses. Consequently, the Court reduces his uniform expense deductions to $500 for both 2003 and 2004.

Farming Losses

Finally, the Foriests reported a $24,116 net loss on Schedule F, Profit or Loss from Farming. The IRS disallows all their farming deductions because their farming activity did not rise to the level of a trade or business. As such, their deductions are limited by section 183, the hobby loss rules. One quote from the Tax Court says it all:

Keeping petitioner’s observation in mind [“nobody farms as a hobby”], as we view the matter, living on a family farm and the purchase of two cows, without more, does not a farmer make.