by Karl L. Fava, CPA as appeared in the Spring, 1997 edition of The Bottom Line, (Fuqua School of Business) and as appeared in the Monday, February 3, 1997 edition of The Wharton Journal, (Volume 41, Number 4)
As a graduate business school student you may be unaware that your educational expenses may be deductible for federal income tax purposes. Given the dramatic cost of your graduate business school, the tax shield created with this deduction considerably reduces the overall cash outlay for your MBA.
The Internal Revenue Code and regulations thereunder clearly indicate that educational expenses are deductible in one’s trade or business. The interpretation of the rules can sometimes be confusing. This is especially true when you consider that there is case law which has set precedence in this area. Between statutory and case law you can easily find yourself wondering how the rules can apply to your particular situation. Generally, your education must meet certain requirements before the expenses can be deducted. The education must be required by your employer or the law to keep your salary, status, or job, and serve a business purpose for your employer, or maintain or improve the skills needed in your present work.
Even if your education meets one of the requirements above, it would not be qualified education, if it is needed to meet the minimum education requirements of your present trade or business; or is part of a program of study that can qualify you for a new trade or business even if you have no plans to enter that trade or business.
Over time taxpayers and the Internal Revenue Service have interpreted the laws relating to educational expenses in different ways. Because of this controversy has occurred. Specifically, the Internal Revenue Service has challenged some taxpayers in their attempts at deducting graduate B-School expense. One of the most noteworthy cases was Stephen G. Sherman vs. Commissioner. Upon completion of his undergraduate degree Mr. Sherman entered the army, serving as an officer. He was temporarily unemployed after this service, and eventually secured employment with the army and air force exchange program. His primary responsibilities included management and administration among other duties. After two years in this position he entered the graduate business school at Harvard. Upon completion of the MBA program, Mr. Sherman obtained a position as a Director of Planning and Research in a private sector corporation. Mr. Sherman deducted the cost of his graduate education on his income tax returns and was challenged by the Internal Revenue Service. The tax court found in favor of Mr. Sherman and allowed him the deduction. The court reasoned that Mr. Sherman was allowed the deduction as he had established himself in a trade or business before he matriculated at Harvard, specifically that of a manager and administrator. His study at Harvard was for a temporary and definite period of time, and he stayed in the same field, trade or business, after graduation.
In writing this article we contacted Robert Willens of the Mergers and Acquisitions department of Lehman Brothers in New York. Willens is a renowned corporate tax specialist and also a proponent for the tax deductibility of graduate business education expense. Willens said, “If someone has established themselves in a career like banking for at least two years, and subsequently obtains an MBA, and continues the pursuit of their trade of banking, then the expense attributable to their business school education should be deductible”. Undergraduates holding jobs in corporate finance and management consulting are in unique positions. They are usually expected to go back to graduate business school after two or three years on the job. As Willens notes, if they return to the field they have established themselves in then there is good basis for a deduction for their graduate business school expense.
The University of Pennsylvania is not only renowned for its famous business school but for the noteworthy Professor Carl Polsky. Dr. Polsky is an accounting professor at Wharton who once a year conducts a seminar where he advises the B-School students on the merits of this type of deduction. In Dr. Polsky’s seminars he also espouses the potential for tax deductions for temporary living expenses while a B-School student is out of town on an internship.
In search of another reference for this type of deduction we spoke with Larry Manth, Partner in the corporate tax division of the Los Angeles office of Deloitte & Touche, LLP. Manth, who earned his MBA at the GSB at the University of Chicago, suggested the following: “Some type of nexus has to occur between the occupation of the taxpayer prior to B-School, and the post occupation to obtain the deduction for business school expenses. As an example, if someone could connect their experiences as a financial analyst to their post MBA position as a commercial banker then there is basis for the deduction. Given, that finance is a common denominator in the prior and post employment, then I feel that an argument could be made that there is nexus, thereby laying the groundwork for a deduction”. Manth, additionally stated: “Taxpayers need to be aware that the utilization of these expenses may subject them to the alternative minimum tax”.
Another tax court case where the taxpayer obtained the deduction for the cost of an MBA was Robert C. Beatty. Mr. Beatty was an engineer whose duties had progressed to managing more than one hundred other engineers. Mr. Beatty matriculated at a graduate business school and obtained a Masters of Science in Administration. Clearly, the additional skills obtained in this program enhanced Mr. Beatty’s existing technical skills. The court concurred with this and Mr. Beatty was allowed to deduct the educational expenses attributable to the attainment of his Business Masters Degree.
Unfortunately, because the basis for this deduction is rooted in both statute and case law it is very hard to interpret to one’s situation. This being the case, the Internal Revenue Service attempts to interpret the laws in their favor which is the same tactic that you as a taxpayer must do. Because this is a complicated matter it would be prudent to discuss it with your tax adviser.
You may have the opportunity for other tax deductions specific to MBAs. As long as you can claim a residence, (home), typically in the city where you are going to school, then you can deduct expenses attributable to temporary travel while on internship. These temporary travel expenses would include lodging and meals. Another area for potential deductions is your job search expenses. As long as your attempt at obtaining a job is in your established trade or business then your expenses attributable to the search would be deductible. These expenses would include your travel, telephone calls, assistance in printing resumes, and various other expenses of this nature.
As you know, the monetary investment of obtaining an MBA is immense. Your expectation is that this investment will reward you in many ways. One way to minimize your investment is to analyze your specific situation, with the assistance of a qualified tax consultant, and determine if you can reduce your cost by obtaining a tax deduction for your graduate business school expense.
Karl L. Fava, CPA MBA is president of Business Financial Consultants, Inc., (BFC), located in Dearborn, Michigan, and has been practicing for over fifteen years. His firm handles tax and financial matters for individuals located on five continents. In the United States, BFC has clients in most major cities. Along with assisting business people world wide in maximizing tax and financial strategies BFC has been assisting clients in deducting MBA expenses for over ten years. BFC’s web site is www.bfcinc.com. Mr. Fava’s e:mail address is firstname.lastname@example.org.