Ruling Allows Deduction on an M.B.A. Degree

by | March 10, 2009

Business-school students may soon have better luck deducting their tuition expenses, thanks to a new tax-court ruling.

People who pursue a master's degree in business administration are allowed under Internal Revenue Service rules to deduct as a business expense school-related costs, which can exceed $40,000 a year at top-tier institutions. But in recent years, the IRS has increasingly challenged these deductions. A string of recent court decisions have also ruled against taxpayers.

Now, there may be a glimmer of hope. Last week, the U.S. Tax Court ruled in favor of one petitioner's ability to deduct his M.B.A. expenses. Tax experts say the decision could be used as a precedent for other courts and taxpayers to follow. "After all we've seen in the past couple of years, [this case] seems to swing the pendulum back a little bit," says Robert Willens, a tax and accounting expert at Lehman Brothers Holdings Inc.

Under Section 162 of the IRS code, taxpayers can deduct educational costs as a business expense if the coursework maintains or improves skills required in their current jobs or if the education is required to keep their present salary, status or job. If, however, the education qualifies the taxpayer to work in a new career or if the coursework is necessary as a minimum-education requirement for a job, then such expenses aren't deductible. That is why doctors and lawyers usually can't deduct their tuition costs -- they need to graduate with degrees from medical and law schools in order to work in those fields.

"While having the M.B.A. might help you get to a position, there is no legal impediment to getting a job without an M.B.A. as there would be for careers that have licensing requirements," says Bob Scharin, editor of RIA's "Practical Tax Strategies," a monthly journal for trade professionals.

In the latest case, the court said the petitioner, Daniel Allemeier, who had obtained an M.B.A. from Pepperdine University while working at a dental-services company, could deduct his tuition expenses because the "basic nature" of what he was doing before and after his degree didn't significantly change. In other cases in recent years, the courts -- looking beyond the business the taxpayer was already engaged in -- have denied the deduction because the M.B.A. degree would have qualified the taxpayer to work in a new job, regardless of whether he or she went to work there or not.

The decision should give taxpayers more comfort with deducting business-school expenses, especially if they end up working in a job where they are using many of the same skills that they were using before business school, experts say. "The way I viewed it, this was a degree that enhanced the skills I already had rather than train me for a new skill," Mr. Allemeier says.

M.B.A. expenses, considered miscellaneous itemized deductions, are deductible only to the extent that total expenses exceed 2% of the taxpayer's adjusted gross income. For those who qualify, the tax savings can be significant.

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