Wednesday, December 27, 2006

IS AN MBA DEDUCTIBLE

You can deduct as an “employee business expense” the cost of education that is (1) expressly required by an employer, by law, or by government regulation, or (2) maintains or improves skills required in your current trade or business.

Education is not deductible if it (1) is the minimum requirement for a trade or business, or (2) prepares one for a new trade or business, even if the taxpayer does not intend to enter the new trade or business.

Deductible expenses include –

· tuition, textbooks, registration fees, and supplies,
· round-trip transportation to the education,
· meals (at 50%) and lodging while away from home,
· lab fees, student cards, insurance and degree costs, and
· writing expenses for term papers and dissertations (i.e. research and typing).

Are the costs of obtaining a Masters in Business Administration (MBA) or equivalent degree deductible as a business expense? According to the Tax Court – Yes and No.

YES: A taxpayer was employed to sell sports-related products because of his prior experience in sports medicine. In the course of his job he performed management, marketing and financial tasks. Encouraged by his employer, he enrolled in an MBA program in the hopes of “moving up the ladder”. As a result of his studies he was promoted.

The Tax Court, in D.R. Allemeier Jr, T.C. Memo 2005-207, found that –

· Encouraging the taxpayer to obtain an MBA degree as a means of advancing through the company did not amount to a “minimum requirement” for promotion, and neither did the fact that the taxpayer actually advanced as a result of the MBA program;

· The MBA degree did not prepare the taxpayer for a new trade or business, as he was already per-forming managerial and financial tasks before enrolling in the program, and, while he was promoted as a result of the MBA, he did not change the basic nature of his duties; and

· While a degree that qualifies a taxpayer for a professional certification or license, such as a law degree, may prepare him for a new trade or business even though he had previously been performing essentially the same tasks, an MBA does not qualify one for a professional certification or license.

The cost of the MBA degree was deductible.

NO: A taxpayer had been employed by several financial firms as a “financial analyst”. In the investment banking industry a financial analyst is a temporary position which usually does not last more than 2 or 3 years. An MBA degree is a requirement for an “associate”, which is a permanent position. The taxpayer received a Master of Management degree, the equivalent of an MBA, and obtained a position in the general management program of a management firm.

The Tax Court, in Will M McEuen III et. ux. v. Commissioner, T.C. Summary Opinion 2004-107, found that –

· The taxpayer enrolled in the degree program to meet the minimum education requirement for an associate in the investment banking industry; and

· The degree qualified for a new trade or business because the education allowed the taxpayer to perform significantly different tasks than those performed prior to enrollment in the program.

The cost of the degree program was not deductible.

As is often the case in tax law, the “deductibility” of an MBA degree depends on the “facts and circumstances.

If you cannot deduct your MBA as a business expense all is not lost. You may be able to claim some of the tuition and fees as a deduction or credit elsewhere on the return. But that is the subject of another posting.

TTFN

9 comments:

William said...

Thanks for the detailed explanation.

I was wondering if there has ever been a case for a technical person who purses an Technical Management MBA, and whether the expenses are tax-deductible.

To illustrate this case, let's take an example of an engineer who wants to "move up to the ladder".

To be promoted to a manager in the engineering department, one doesn't need an MBA. That person needs to accumulate more years of technical expertise. The MBA will enhance that person's candidacy due to the improved management skills. This means the MBA is not a minimum requirement for promotion.

However, how does this apply to the second requirement, whether the MBA will open up more possibility into any new fields. The Technical Management MBA means that the person may eventually work for any industries in the technical position. For example, if that person initially has a degree in computer engineering, a Technical Management MBA will open up opportunities as a manager in chemical engineering, mechanical engineering, etc.

Does this mean that the second requirement is not fulfilled? Does the person need to be extra careful with the courses taken in the MBA program? An MBA course in Finance, Accounting or Sales/Marketing may eventually qualify that person into many other fields.

Robert D Flach said...

William-

The second exception says that education is not deductible if it qualifies the taxpayer for a new line of work, even if the taxpayer does not intend to enter that new line of work.

The answer to your question concerning the engineer who wants to “move up the ladder” can be found in the court’s response in the Allemeier case discussed in the posting.

As I said in the posting the court agreed that the cost of the MBA was deductible because –

* “Encouraging the taxpayer to obtain an MBA degree as a means of advancing through the company did not amount to a 'minimum requirement' for promotion, and neither did the fact that the taxpayer actually advanced as a result of the MBA program.” This seems to apply to your example, as you have indicated.

* “The MBA degree did not prepare the taxpayer for a new trade or business, as he was already per-forming managerial and financial tasks before enrolling in the program, and, while he was promoted as a result of the MBA, he did not change the basic nature of his duties.” Was the engineer in your example already performing managerial and financial tasks as part of his position prior to enrolling in the MBA program? If not, and he was just an engineer doing engineering tasks, then it could be said that the MBA prepared him for a new trade or profession as a manager.

Does anyone out there have anything to add to the discussion?

TWTP

William said...

Robert,

Thanks for the feedback.

I think with the second exception ruling it would be very difficult for an engineer to make the MBA costs tax-deductible. In general, an engineer performs engineering tasks. A lead engineer or engineering manager supervises other engineers and at the same time performs other higher-level engineering analysis such as supply chain etc. However, it is not common for an engineering manager to perform financial analysis or other sales / marketing efforts. Thus, it seems very unlikely that MBA costs can be deductible.

For the Allemeier case, he was hired to the Sales / Marketing department as result of his degree in Sports Medicine (requirement 1). And with his position, he performs managerial tasks and financial analysis. So although he doesn't have a degree in Business, he is already performing many Business-related tasks. In a way, by getting hired into the Sales / Marketing department, he already qualifies for the "Business" trade. Thus, an MBA will not prepare him for a new trade, but rather the MBA will improve his position in the "Business" trade.

Going back to my example, I think in order for an MBA to be deductible, an engineer should go for a Sales / Marketing position, preferably in a supervisory role, where the hiring decision is based on the engineering experience. In that way, this person can satisfy both requirements for tax-deductibility on MBA expenses.

This is a very interesting argument. I think an MBA is very useful for everyone in any position. At the end of the day, it is always about Business and Management. Thus, having a perspective from the Business / Management side will be beneficial. However, an MBA is so general that a person will almost qualify for a new profession, except for the people who have a Business degree to begin with or who are already in the "Business" trade. With that being said, costs related to further graduate studies in Engineering may actually qualify for tax-deductibility for engineers.

By the way, this is a great blog. Good job.

William

Robert D Flach said...

William-

Thanks for the kind words about the blog.

TWTP

Amy said...

Hi Robert,

Thanks for the insight into the wonderful world of taxes :). What happens in case of a person getting partially reimbursed for an MBA.

Say the company feels the MBA is necessary for maintaining your current job and gives you $5,250 tax free a year towards it. If your yearly tuition cost is $30,000, can you deduct 14,750 - 2%AGI from your taxes or are you allowed no further deductions?

Robert D Flach said...

Amy-

I will be answering your question in a post to another of my tax blogs ASK THE TAX PRO at http://askthetaxpro.blogspot.com.

TWTP

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Anonymous said...

Does the more recent ruling in favor of Lori Singleton-Clarke change any of the points above? It seems that the court will not use it as precedence but does it affect the mentality of the IRS or the Appeals office?

http://online.wsj.com/article/SB10001424052748703535104574646582965101664.html
http://www.traveltax.com/Documents/RN%20Gets%20MBA-%20Deductible.pdf

Robert D Flach said...

Anon-

I do not have the time to review the particular case right now - as I am leaving for a tax conference on Sunday.

I will review the case and discuss in a post after I return and the "dust settles".

TWTP