DEDUCTING EDUCATION EXPENSES
Presentation by Michael Fontanello
Fontanello, Duffield & Otake, LLP
INTRODUCTION
The Sixteenth Amendment, which was ratified in 1913, enables the Congress of the
United States of America to levy and collect income taxes. The first revenue code was
compiled in 1939 and comprised of various revenue acts passed from 1913 to 1939.
Since 1939, the tax law has been re-codified twice: once in the Internal Revenue Code of
1954 and once again in Internal Revenue Code of 1986.
The Internal Revenue Code (IRC) serves as one source of tax law from the legislative
branch of government. Other sources of tax law include Revenue Rulings, Revenue
Procedures, and Letter Rulings issued by the Internal Revenue Service (IRS). The IRS, a
branch of the Treasury Department, is part of the executive branch of government and is
responsible for the administration of federal tax law. The third branch of government, the
judicial branch, provides tax law through court decisions often based on disputes between
taxpayers and the IRS. These cases take place in all levels of the judicial system and the
highest form of appeal for such a case is the U.S. Supreme Court.
Income taxes paid directly by individual taxpayers historically account for the largest
portion of taxes paid to the federal government annually at around 45% of total income
taxes collected. Income tax rates for individuals are progressive, meaning that the tax
rates for individuals increase as the amount of taxable income increases. (See
Supplemental Information). Taxable income is usually calculated by subtracting
exclusions, deductions, and exemptions from the total income of the taxpayer. The tax
rate is then applied to taxable income, income tax is calculated, and tax credits are
subtracted from the calculated income tax to arrive at the total tax liability for any
taxpayer.
Deductions for individual taxpayers usually fall into two types: deductions from adjusted
gross income (AGI), and deductions for AGI. Adjusted gross income is a taxpayer’s total
gross income minus specific reductions. Deductions from AGI usually include the
government determined standard deduction or the taxpayers’ itemized deduction if that
amount is greater than the standard deduction. Reductions to arrive at AGI often include
expenses related to a business or rental property, moving expenses, contributions to an
IRA, or other specified allowable deductions.
A number of returns filed by taxpayers every year are selected for examination by the
IRS because the tax system in the U.S. is based on self-assessment and voluntary
compliance. This process of examination is usually referred to as an audit and during this
process a taxpayer is asked to substantiate deductions, credits, or income items for a
given tax year or many given tax years. Certain situations increase the likelihood that a
taxpayer might be audited and include: individuals who are self employed with
substantial business income, filing a return in which itemized deductions exceed an
average amount for the taxpayer’s income level, sole proprietors who claim deductions
for business expenses on a return that involves significant tax losses.
Deducting Education Expenses
1
Presentation by Michael Fontanello of Fontanello, Duffield & Otake, LLP
Chris Mulanax, Contributor
01/26/2012
OVERVIEW OF DEDUCTING EDUCATION EXPENSES
Every taxpayer must take into account their specific facts and circumstances, the tax
code, and applicable tax law each tax year and decide whether certain available
deductions or credits are applicable.
I. Deducting MBA Education Expenses
a. Qualifying Attributes
i. Must be enrolled at least half time in a degree program
ii. Citizenship- Nonresident alien students do not usually file a
Form 1040 in the United States unless certain income has been
received from a University for research or scholarship
iii. Un-reimbursed Business Expenses
1. Must have documentation of expense being submitted to
employer and rejected for reimbursement by employer in
order to deduct
b. Deductible Expenses
i. Tuition and fees
ii. Lab fees
iii. Required books and equipment
iv. Room and Board
NOTES: IRC Code Sections about Deductible Expenses
 I.R.C. § 162(a) – There shall be allowed as a deduction all the ordinary
and necessary expenses paid or incurred during the taxable year in
carrying on any trade or business
 T.R. § 1.162-5(a) – Expenditures for education made by an individual
are deductible as ordinary and necessary business expenses if they
meet 2 criteria
o The education Maintains or Improves skills required by the
individual in their employment or
o The education meets the express requirements of the
individual’s employer as a condition of retention
NOTES: IRC Code Sections about Nondeductible Education Expenses
 T.R. § 1.162-5(b) – Educational expenses are not deductible if they are
made to obtain the minimum educational requirement for qualification
in the individual’s employment
o Example: E is enrolled in a three year law school then plans on
sitting for the bar exam. The law school education and bar
exam expenses would not be deductible as they are required to
meet the minimum education requirements to practice law.
 T.R. § 1.162-5(c) – Educational expenses are not deductible if the
education will qualify you for a new trade or business
o Example: E is an accountant who decides to attend law school
at night. The educational expenses would not be deductible
since they would qualify E for a new trade or business.
Deducting Education Expenses
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Presentation by Michael Fontanello of Fontanello, Duffield & Otake, LLP
Chris Mulanax, Contributor
01/26/2012
II. Case Law about Deductibility of MBA
A. Daniel R. Allemeier, Jr. v. Commissioner (T.C. 2005)
i. Meeting the minimum education requirement typically means that
an employee must have a particular degree before being hired or
within a certain period after being hired
ii. Whether an education qualifies a taxpayer for a new trade or
business depends upon the tasks and activities he was qualified to
perform before the education and those that he was qualified to
perform afterward (Glenn v. Commissioner, 62 T.C. 270, 275
(1974))
iii. The court has repeatedly disallowed education expenses where the
education qualifies the taxpayer to perform “significantly”
different tasks and activities
iv. Simply acquiring new titles or abilities does not necessarily
constitute the entry into a new trade or business (Glenn v.
Commissioner, supra)
B. Singleton-Clarke v. Commissioner (T.C. 2009)
i. Facts
1. Taxpayer deducted $14,787 in educational expenses for
obtaining her MBA with an emphasis in Health Care
Management. The IRS allowed the deduction
2. Taxpayer was a RN and worked for 24 years in various
capacities in hospitals, medical centers and long-term care
facilities
3. Taxpayer had received six significant awards of merit over
her 24 years of employment
4. Taxpayer paid the entire cost of her MBA; none of her
employers offered a tuition reimbursement plan for a MBA
ii. Finding
1. The performance of services as an employee constitutes a
trade a business Primuth v. Commissioner, 54 T.C. 374, 377
(1970)
2. For such expenses to be deductible, the taxpayer must not
have the right to obtain reimbursement from his employer.
Orvis v. Commissioner, 788 F.2d 1406, 1408 (9th Cir. 1986),
affg. T.C. Memo. 1984-533
3. Education expenses are not deductible if they qualify the
taxpayer for a new trade or business, regardless of whether
they intend to enter said trade or business
4. The deductibility of an MBA is objective and depends on the
facts and circumstances of each case
a. Where a taxpayer is going straight from their
undergraduate studies into a MBA program the law
has not allowed a deduction. Link v. Commissioner,
90 T.C. 460, 463-464 (1988)
b. Where a taxpayer has gone straight from the military
into a MBA program the law has not allowed a
deduction. Schneider v. Commissioner, T.C. Memo.
1983-753
5. The key elements to deductibility of a MBA are the tasks and
Deducting Education Expenses
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Presentation by Michael Fontanello of Fontanello, Duffield & Otake, LLP
Chris Mulanax, Contributor
01/26/2012
duties which the taxpayer was qualified to perform prior to
entering their MBA program
a. Army officer who left the military for a civilian
position for one year prior to beginning a full time
MBA program was allowed a deduction. Sherman v.
Commissioner, T.C. Memo. 1977-301
b. A taxpayer who was employed as a Salesperson, but
who worked their way up to a management position
was allowed a deduction based on the responsibilities
they had prior to beginning a part time MBA.
Allemeier v. Commissioner, T.C. Memo. 2005-207
6. A taxpayer who temporarily ceases active participation in a
trade or business during a transition period between leaving
one position and obtaining another may be carrying on a
trade or business during the transition period. Haft v.
Commissioner, 40 T.C. 2 (1963)
III. Specific Deductions, Credits and Tax Benefits for Education
A. Lifetime Learning Credit (Below the Line)
i. Non-Refundable credit
ii. Annual limit of 20% of the first $10,000 of expenses
iii. May be used for any educational expenses to improve job skills
iv. Includes expenses paid by student loans
v.
Phased out for AGI over $51,000 - $61,000 for Single & $102,000
- $122,000 for Married filing jointly
B. Student Loan Interest Deduction (Above the Line)
i. Deduction of up to $2,500
ii. Applies to loans for graduate and undergraduate study
iii. Student must have been enrolled at least half-time in degree
granting program in applicable tax year
iv. Can include required books and supplies, equipment, room &
board, transportation & other necessary expenses
v.
If married, you must file a joint return for the deduction
vi. Does not include any loan owed to a related person
vii. Phased out for AGI over $60,000 - $75,000 for Single & $120,000
- $150,000 for Married filing jointly
C. Scholarships, Fellowships, Grants, and Tuition Reductions
i. Amounts received may not be taxable
ii. Does not phase out with higher AGI
iii. Applies to monies received for graduate study
iv. Paying tuition and fees, purchasing required books, supplies, and
equipment with monies received may be a qualifying expense
v.
Does not apply to room and board expenses (If Room & Board is
included in the scholarship that portion is taxable)
vi. Does not apply to payment for teaching, research or other services
provided by the student as a requirement for a scholarship or
tuition reduction. (Taxable Income)
D. Employer Provided Educational Assistance
i. Assistance provided by employer may not be taxed up to $5,250
ii. Can apply to both undergraduate and graduate study
Deducting Education Expenses
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Presentation by Michael Fontanello of Fontanello, Duffield & Otake, LLP
Chris Mulanax, Contributor
01/26/2012
E. Educational Exception on Early IRA Distributions
i. Early distribution for purpose of paying education expenses will
not be charged 10% early withdrawal penalty
ii. Can apply to both undergraduate and graduate study
NOTES:
 Payments made in December of one year for academic periods that
begin in the first quarter of the following year are allowable
deductions in the year paid
Deducting Education Expenses
5
Presentation by Michael Fontanello of Fontanello, Duffield & Otake, LLP
Chris Mulanax, Contributor
01/26/2012
SUPPLEMENTAL INFORMATION
Specific Deductions, Credits, and Tax Benefits for Education
Lifetime
Learning Credit
Benefit
Tax credit can
reduce overall tax
liability owed by
taxpayer
Student Loan
Interest
Deduction
Deduction can
reduce taxable
income
Scholarships,
Fellowships,
Grants, and
Tuition Reduction
Employer
Provided
Educational
Assistance
Educational
Exception of
Early IRA
Distributions
Amounts received
may not count as
taxable income
Employer
provided benefits
not taxed as
income to
employee
No 10% penalty
on early
distribution spent
on education
Annual
Contribution
Limit
$2,000 per family
Up to $2,500
None
$5,250 exclusion
Amount of
qualified
education
expenses
Adjusted Gross
Income Phase
Out Range
Single- $51,000$61,000; MFJ$102,000-122,000
Single- $60,000$75,000; MFJ$120,000$150,000
No phase out
No phase out
No phase out
Qualifying
Education
Undergraduate
and graduate
courses to acquire
or improve job
skills
Undergraduate
and graduate
K-12,
undergraduate
and graduate
Undergraduate
and graduate
Undergraduate
and graduate
None
Required books,
supplies, &
equipment; room
& board,
transportation &
other necessary
Required books,
supplies, and
equipment; does
not include room
& board
Required books,
supplies and
equipment
None
None
Must have been at
least a half-time
student in a
degree program
1)Must be a degree
or vocational
program
2) Payment of
tuition and fees
allowed under grant
None
None
Qualifying
Expenses (In
addition to tuition
and required
enrollment fees)
Additional
Requirements
Lowest
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Summary of Ordinary Income Tax Rates
10%
Next
15%
Next
25%
Highest
28%
33%
35%
Links to Cases
Daniel R. Allemeier, Jr. v. Commissioner
http://www.ustaxcourt.gov/InOpHistoric/allemeier.TCM.WPD.pdf
Singleton-Clarke v. Commissioner
http://taxlaw.typepad.com/files/singleton-clarke.sum.wpd.pdf
Deducting Education Expenses
6
Presentation by Michael Fontanello of Fontanello, Duffield & Otake, LLP
Chris Mulanax, Contributor
01/26/2012