of Advanced Business Degrees
SEPTEMBER 2005 - The
Master’s Degree in Business Administration (MBA) has
been popular for decades, symbolizing advanced competencies
in business management. Costs for completing an MBA range
as high as $100,000 to $120,000. The incentive is an average
starting salary of approximately $75,000, well above the 2002
average starting salary for undergraduates of $41,000.
costs and benefits of the degree and its affect on lifetime
earnings are obvious. Another substantial factor to consider
is that the costs of acquiring the degree are often tax-deductible.
For qualifying individuals, the tax savings are substantial,
as the individual’s AGI often lowers during graduate
school attendance, resulting in a more beneficial deduction.
For self-employed individuals, the deduction lowers AGI
and income subject to self-employment, resulting in even
greater tax benefits.
allowance of the deduction for education expenses is included
in IRC section 162 under the wide-ranging concept of “a
deduction of all the ordinary and necessary expenses …
in carrying on any trade or business.” Further analysis
of this deduction reveals certain complexities in determining
qualified education expenses.
Regulations section 1.162-5 (last revised in 1967) expands,
explains, and provides examples related to the specifics
of the deduction of education expenses. In general, the
following must be met for the expense to be deductible:
It is not required in order to meet the minimum educational
requirements for qualification in employment, or other
trade or business;
It is not part of a program of study which will lead to
qualification for a new trade or business; and
It will maintain or improve skills required by the individual
in employment or other trade or business, or
It meets the express requirements of the individual’s
employer, or meets the legal requirements to maintain
the individual’s employment, status, or rate of
U.S. Tax Court has recently taken issue with the construed
standard of maintaining and improving skills required for
employment, as opposed to improving competence necessary
for a new position. More specifically, the general nature
of a business program, with the variety of courses ranging
from accounting to electronic commerce, combined with the
sizable tuition charged by top-ranked graduate schools,
has broadened the nature of the deduction and caused the
IRS and courts to examine the issue more closely as it relates
to the MBA or other postgraduate business management degrees.
exist with the various court and IRS rulings on this topic.
An analysis of the more prominent issues contained in the
IRC and Treasury Regulations provides a useful gauge to
assess the possibility of sustaining a deduction.
and Necessary Expenses of a Trade or Business
broad requirements contained in IRC section 162 provide
the foundation for the education deduction. The trade or
business determination includes continuous and regular activity
for income or profit at the time the expenses are incurred.
Without this minimum level of compliance with section 162,
the education deduction will be disallowed. The courts have
generally considered employees to be engaged in a trade
definition of education expenses reaches beyond the standard
tuition, fees, and books. Costs associated with a management
consultant hired for private tutoring have been allowed.
For those individuals incurring expenses “away from
their tax home,” travel, transportation, meals, rent,
utilities, and lodging qualify. A 1982 case reiterated that
if the taxpayer’s costs were primarily educational
versus personal, the business aspect of the deduction is
the primary motivation, and as such they are deductible.
Commuting expenses are nondeductible, however, unless incurred
from work to the class where qualifying education expenses
Supreme Court addressed these requirements by stating that,
under IRC section 162, “to qualify for the business
deduction the expense must relate to the existing, as opposed
to the future, occupation of the taxpayer.” Relying
on this decision, Revenue Ruling 77-32, which was foundational
in its definition of “existing” trade or business,
disallowed an anesthesiologist’s deduction of expenses
related to maintaining his skills during a time when he
was not practicing medicine.
have allowed a leave of absence from work to pursue an MBA
degree as long as the taxpayer assumes a similar job upon
return. A 1977 case concluded that the IRS would accept
periods of less than a year’s absence from employment.
Longer periods have been accepted if the taxpayer actively
sought a position upon graduation. A 1970 tax court case
allowed a taxpayer a two-year absence from work because
he returned to a comparable position as manager at another
with an undergraduate degree that work for a short period
of time (such as a summer position) and return to an MBA
program generally are disallowed a deduction. The taxpayer
must be in the workplace long enough to be engaged in an
active trade or business.
cases have involved variations of the trade or business
requirement. In Weyts (TC Memo 2003-68), a non–U.S.
citizen taxpayer held a law degree from Belgium, and received
a Master of Laws (LLM) in corporate finance in the United
States. He passed the New York State bar exam before obtaining
work as a summer associate, and was advised to return to
school to obtain his JD degree. The
courts determined that admission to the bar was not necessarily
considered “engaged in a trade or business of practicing
law” and the costs in question were related to obtaining
the minimum education (JD) necessary for a position after
graduation; therefore, the deduction was disallowed.
or Improve Skills Required by an Employment
regulations provide the detailed language regarding the
allowance of the deduction. First and foremost, the taxpayer
must be involved in a trade or business or employment situation
where the education expense is required due to the necessary
maintenance or enhancement of the individual’s skills.
Tax Court has said that the education need only “enhance
the taxpayer’s existing skills” and that the
education obtained should have a “direct and proximate
relationship” to the business purpose of the individual’s
employer. Only the minimum education necessary for retention
qualifies. Nonetheless, a change in responsibility does
not constitute a new trade or business if the new duties
involve the same general type of work.
fact that an individual is already performing service in
an employment status does not establish that he has met
the minimum educational requirements for qualification in
that employment. Yet once met (when effectively entering
employment, or the trade or business), the employee shall
be treated as continuing to meet those requirements even
though they are changed.
courts delineate between the improvement of skills and the
improvement of oneself. For the MBA degree, this generally
requires the taxpayer to have some type of administrative
or management position involving interpersonal and communication
skills prior to receiving the education. Courts and the
IRS disallow a deduction where the skills acquired through
the educational expense appear to be only remotely related
to the profession (lack of proximate and direct relationship).
Representative cases included the disallowance of an MBA
for an army attorney, an airline pilot, and a quality-control
Expenses Required by Employer or Law
regulations, which are very specific in this area, indicate
that the education must meet the express requirements of
the individual’s employer, the law, or applicable
regulations for retaining an established business relationship,
status, or compensation rate. This includes education customary
for others in the profession to obtain similar education
for the retention or enhancement of competencies. Taken
literally, the education expenses must be specifically required,
either in writing or by other explicit communication. Does
an employer “require” an MBA from an employee?
Does the employee assume that, in order to maintain competence,
further education is necessary?
case involved an engineer who was reimbursed by his employer
for costs associated with his MBA. The courts disallowed
the deduction by the business, indicating that the business
reimbursement policy was more relaxed than the law, and
thus the reimbursed costs should be considered income to
Revenue Ruling allowed a navy captain to deduct his Master
of Arts in Personnel Administration. This ruling acknowledged
that although the degree was not required by the employer
for retention, promotion, or salary enhancement, and the
taxpayer chose to take the courses of his own accord, the
courses were nonetheless “so closely related to his
employment duties that they served to maintain or improve
the skills required of him in his employment … and
the courses taken by the taxpayer were not part of a program
of study that would qualify him for a new trade or business.”
decision in McEuen (TC Summary Opinion 2004-107)
made the popular press after the taxpayer was denied the
deduction of the cost to obtain an MBA at Northwestern.
After an undergraduate degree, McEuen worked for two financial
analyst firms where it was known that an MBA was a prerequisite
for promotion. She resigned her position to obtain the degree,
but after graduation worked in industry in general management,
where an MBA was required. The court stated that McEuen
performed significantly different tasks and activities after
receiving her MBA.
for a New Trade or Meeting Minimum Educational Standards
examine the taxpayer’s ability to perform significantly
different tasks and activities after obtaining additional
education, thus providing support for new competencies versus
the enhancement of existing skills. Specialties obtained
must be in the same general type of work. The degree-seeking
individual must return to the same general type of work.
Consequently, education expenses that appear to provide
opportunity for position advancement are examined carefully.
disciplines appear to be scrutinized differently. Teachers
receive some leniency when required to obtain additional
competencies in order to teach in a new school district.
Attorneys, however, have been disallowed a deduction related
to costs incurred to practice law in a new state. Revenue
Ruling 74-78 allowed a dentist practicing general dentistry
to deduct the costs of postgraduate studies in orthodontics
even though, following the completion of his degree, he
limited his practice to orthodontic patients. Costs for
law school, however, regardless of whether required by the
employer or used in the professional’s job, are specifically
considered nondeductible by the regulations.
conservative interpretations have been affirmed more recently
in Galligan (TC Memo 2002-150). The taxpayer, a law-library
manager, obtained a law degree to enhance skills used daily
in her position. She did not practice law, and her employer
did not require the degree. Galligan argued that the $18,000
spent on the cost of her education maintained and enhanced
her skills, but the court disallowed the deduction.
IRS- or court-approved deductions in the legal, education,
and dentistry professions provides a basis for evaluating
whether an advanced business degree will qualify as a legitimate
deduction. In Lewis (TC Summary 2002-49), the taxpayer
attended UCLA’s MBA program to obtain additional business
skills. Lewis stated that he needed to enhance his accounting,
financial, and general business skills to help with contract
negotiations in his current position. He agreed that the
MBA would also qualify him for a “wider variety of
positions.” The courts disallowed the deduction.
(TC Summary Opinion 2003-58) addressed an individual receiving
an MBA from the Massachusetts Institute of Technology. A
large brokerage firm assured the taxpayer that he would
have a job upon completion of his education. The court considered
this to be a new trade or business, and the deduction was
section 162 permits ordinary and necessary expenses required
to carry on a trade or business, including costs associated
with qualifying education. The regulations give extensive
details on what kinds of education qualify (maintaining
or improving skills, meeting requirements for employment
retention) and what kinds do not (qualifying one for a new
trade or business). These generalized requirements can be
a challenge for taxpayers to interpret, but the courts have
maintained a strict analysis and generally support the IRS
court and IRS rulings provides critical information for
taxpayers considering the deduction. The courts and the
IRS have shown more leniency in certain disciplines, such
as education and dentistry, than in others, such as business
and law. Education expenses that either potentially or directly
allow position advancement are generally disallowed.
advanced business degrees, these issues are seldom black
and white. Court rulings differ widely from case to case.
Generally speaking, the courts and the IRS appear to be
continuing their conservative approach when interpreting
the requirements of qualifying deductible education expenses.
Taxpayers will be more likely to secure the education expense
deduction if they have fully researched all the related
issues and rulings.
Bolt-Lee, CPA, is an associate professor in accounting
at the Citadel in Charleston, S.C.