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Tax Court: Tough Test for Business Education Deduction

Nov 28th 2017
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Can a taxpayer deduct the cost of going “back to school” while working or taking a hiatus? It depends. As evidenced by a new case, Czarnacki, Ct. of Fed. Cl. No.  15-13817, 10/13/17, a deduction may be denied if the courses qualify you for a new line of work — even if that’s not your intention. 

For starters, a taxpayer must pass at least one of the following two tests to qualify for a business education deduction:

  1. The education is required by your employer or by law to keep your present job. It must serve a legitimate business purpose.
  2. The education maintains or improves skills needed in your present job.

However, even if you pass one of these two tests, no deduction is allowed if either of the following is true:

  1. The courses are needed to meet the minimum education requirements of your present position
  2. The education is part of a program or study that will qualify you for a new trade or business.

As you can imagine, there’s a lot of “grey area” in these black-and-white rules. In particular, it is difficult to establish whether education qualifies a taxpayer for a new trade or business. Typically, the IRS will argue that the courses are preparing you for another line of work, especially if you’re on the path to masters or another advanced degree. And the landscape is littered with taxpayers who argued their case in court, to no avail.

Here's a classic example: The taxpayer in the new case was a professional engineer with a master’s degree. He had several jobs in the engineering field, steadily moving up the ladder.

Beginning in 2009, the taxpayer began work as an engineer for the Navy Surface Warfare Center. In this position, he focused on how batteries in submarines withstood shocks and vibrational disturbances when the batteries are mounted in a vehicle. He was certified as a Systems Engineer Level 3 in 2010, focusing on oversight of design and manufacture of complex equipment and military hardware.

During this time, the taxpayer also conducted research and writing in connection with his doctoral thesis at MIT. At the time, he was not licensed as a structural engineer. In 2011, the taxpayer left his employment with the Navy and began working for the Institute for Defense Analyses as a research engineer. Eventually, he returned to work in the private sector at his current position as an engineer. In 2014, he stopped working on his doctoral thesis without having obtained a degree.

The taxpayer argued that the expenses incurred in connection with researching and writing his doctoral thesis merely improved his skills in his current field. However, the Court determined that these studies qualified him to become a professor, a new line of work, even though he had no intention of pursuing this path and, in fact, failed to complete his thesis. Therefore, the deduction for business education expenses was denied. 

If a client qualifies for a deduction, such out-of-pocket employee business expenses are deductible as miscellaneous expenses on Schedule A. The deduction for all miscellaneous expenses, including employee business expenses, is limited to the excess of 2 percent of adjusted gross income (AGI). Thus, the deduction may be reduced or eliminated due to the 2 percent-of-AGI limit.

When possible, the best approach may be to have an employer reimburse employees for job-related courses. As a general rule, the reimbursements are tax-free to the employee and deductible by the employer.

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