MBA Deduction

Maryland Nurse Takes on IRS and Wins

The U.S. Tax Court handed Lori Singleton-Clarke (the “taxpayer”) victory, stating that the taxpayer had properly deducted her education expenses as an ordinary and necessary business expense.  The case is significant in two aspects—first, the deduction in question was approximately $15,000 in business school tuition cost; and, second, the taxpayer litigated the case in small claims tax court without representation.

As a backdrop to the decision, tax law generally provides that expenditures for work-related education are deductible, subject to the 2% of AIG limitation, if incurred to obtain a qualifying education. Qualifying work-related education:

• is required by an employer or the law to keep a present salary, status, or job; or
• which maintains or improves skills required for present work.

The taxpayer was a registered nurse with over 24 years of experience working in various capacities in hospitals, medical centers, and long-term care facilities.  In her many years of experience, she garnered six awards for outstanding work and merit.  Her job history reveals that she had significant experience in quality control, patient risk management, investigation of complaints, and implementation of improvements for patients, doctors, and employees.  Her immediate supervisors were department heads and her work was seen by hospital executive management.    

The taxpayer began taking courses at the University of Phoenix in March 2005 and graduating in 2008 with an MBA degree in hospital management.  The reason she pursued the advanced degree was to become more effective in her then-present duties and believed that the degree would give her greater credibility and effectiveness in her present and future role as a quality control coordinator.  When you read the case, it is apparent that her desire to pursue the degree was also motivated by a desire to stay competitive and up-to-date with the doctors with whom she worked.  Although the degree was not required, it was encouraged by hospital management.  The taxpayer paid the entire cost of the program without reimbursement.

The taxpayer’s return was examined by the IRS with the deduction disallowed.  The taxpayer protested the adjustment and having been denied, petitioned the United States Tax Court for review.  The case was heard in small claims thus is not precedent for other cases.  Nevertheless, the case is instructive.

As we are reminded in the opinion, deductions are a matter of legislative grace and taxpayer must satisfy the statutory requirements for deduction.  Taxpayers are allowed to deduct “ordinary” and “necessary” expenses that they incur in connection with operating a trade or business (which specifically includes the performance of services as an employee).  “Ordinary” is defied as usual or customary under the circumstances; “necessary” meaning appropriate or helpful.  The expenditure must also be directly connection with or pertaining to the taxpayer’s trade or business. 

Treas. Reg. 1.162-5 governs whether a taxpayer may deduct education expenses.  The regulation provides that if the education maintains or improves skills required by the individual in his employment; or, meets the express requirement of the employer imposed as a condition of employment, then the education expense is deductible.  An expense to meet the minimum qualification of a position is not sufficient.  Neither is the expense deductible if the education qualifies the individual for a new trade or business. 

As stated by the Tax Court, the relevant standard is whether the education objectively qualifies the taxpayer for a new trade or business—that the taxpayer’s subjective intent is not relevant.  The Tax Court also stated that it is not material whether the taxpayer does in fact become employed in the new trade or business.  There is a plethora of case law on point which makes clear that expenses of education that qualify a taxpayer to enter a new trade or business are nondeductible, regardless of whether the taxpayer actually enters that trade or business. The tasks the taxpayer is qualified to perform before the education are compared to those for which he is qualified after the education to determine whether the education enabled him to enter a new trade or business.  In one situation, a practicing accountant deducted his expenses incurred in pursuing a legal education to improve his accounting skills and obtain a law degree.  The court ruled that the fact the taxpayer neither practiced nor intended to practice law was irrelevant; the deductions were nondeductible under the regulations because it qualified the taxpayer for a new occupation i.e., attorney-at-law.  The Tax Court reached the same conclusion involving an aeronautical engineer who was unable to deduct his flight school expenses because although the training improved his aeronautical engineering skills, it also qualified him to enter a new field as a commercial pilot.

The IRS contended that without the MBA degree, that the taxpayer would not have been able to obtain her current job.  The Tax Court had no problem in finding that the MBA expenditures were ordinary and necessary in helping the taxpayer perform her duties.  Her employment required her to have her RN license or equivalent bachelor’s degree in nursing and to have clinical or risk management experience; credentials which the taxpayer already possessed.  Previous employers had hired the taxpayer without the MBA degree and the current employer job description did not require an MBA degree.  The Court stated that although the MBA degree was helpful, it was not an essential prerequisite for the taxpayer to obtain her job.    

The Tax Court also pointed out that an MBA degree is different from a degree that serves as a qualification to attain a professional license.  The MBA degree is a more general course of study that does not lead to a professional license or certification.  The decisive factor here was that the taxpayer was already well established in her trade or business.  Her job duties did not significantly change because of the MBA degree.  What the degree did accomplish was to improve her pre-existing skills for the same general duties that she was already performing.   

This case definitely provides a road map others can use, especially MBA students, in deduction education expenses.

For more information, please contact Scott Singer, CPA, at 630-420-1360 or ssinger@dhjj.com.

Please always consult with your tax advisor regarding the deductibility of education costs.