Tax law has long allowed a taxpayer to deduct the cost of work-related education if it maintains or improves skills needed in his or her present job or business, or if it is required by an employer.
But education that qualifies a person for a new trade or business, or that is needed to meet the minimum requirements to keep a job the person already has, is not deductible.
For example, a high school history teacher who takes additional history courses to improve her knowledge of her subject would likely qualify. But if she had not yet graduated from college and were teaching on a temporary certificate while taking courses to finish college, there would be no deduction because the degree is a minimum requirement to keep her job. And if she went out and got a law degree there would also be no deduction because, however much the degree might help her with her teaching, it would also qualify her for a new career as a lawyer.
But in some situations the Internal Revenue Service rules aren't so easy to parse. And now, it seems, the IRS is taking a hard line and the U.S. Tax Court is backing it up.
Consider the master of business administration degree. An MBA would presumably improve the skills of someone already working in business. But plenty of senior executives don't have one, so it wouldn't seem to be a minimum requirement for the field. Therefore, business school students already working in the field should be able to deduct the cost of their degrees, right?
Actually, no, the U.S. Tax Court said earlier this month.
In the case of a woman who worked as a financial analyst for Merrill Lynch and later Raymond James Financial Inc. and then left to get her MBA at Northwestern University, the court found that not only was her degree a minimum educational requirement to be an investment banker, but it also qualified her for a new trade or business.
So her deduction failed on both counts.
Though the woman, Tracy L. McEuen, argued that she had been an "investment banker" in both her jobs, the court concluded that the financial analyst position she held at both firms was "a subordinate temporary position lasting a maximum of three years." The next job up the ladder, that of "associate," required an MBA, the court noted.
Further, the court said, "if the education qualifies the taxpayer to perform significantly different tasks and activities than could be performed before the education, the education qualifies the taxpayer for a new trade or business." It then pointed to the fact that after obtaining her MBA, McEuen did not take an investment banking job but instead entered the general management program of a home furnishing manufacturer -- for which an MBA was a prerequisite.
"Although [McEuen's] education would not by itself qualify her for a new profession, the [Internal Revenue Service] regulation requires only that the program of study being pursued 'will lead to qualifying' [the taxpayer] in a new trade or business. Payments for education that must be combined with an examination or experience to qualify a taxpayer for a new trade or business are not deductible," the court said.
The case was tried under the Tax Court's small case procedures -- after various adjustments, McEuen's deduction would have saved her only $2,558 -- so the decision cannot be appealed, nor can it be used as precedent in future cases.
However, to the extent it represents the IRS and Tax Court's view of the rules, it suggests that obtaining this kind of deduction is going to be very tough. Most kinds of higher education, combined with experience, arguably qualify almost anyone for almost any kind of work. The IRS could argue that an MBA virtually always qualifies the holder for a better job.
Further complicating the matter is another rule that this deduction must be taken as an unreimbursed employee expense on Schedule A, meaning that only the amount over 2 percent of the taxpayer's adjusted gross income can be deducted.
Thus, the history teacher who takes a history course at the local community college might qualify for the deduction only to see it wiped out by the 2 percent requirement -- unless the course is very expensive or she is even more underpaid than the average teacher.
This kind of Catch-22 is becoming increasingly common for taxpayers. Such "claw-backs" as the alternative minimum tax, the phase-out of personal exemptions and itemized deductions for higher-income taxpayers, and various income limitations cut benefits at both the high and low end of the income spectrum. They make it unwise to assume that you'll get some deduction or break just because it's in the law.
The lesson today is, if you're thinking of doing something that carries a tax break, and the tax break is important to you, run all the numbers and check the rules first to make sure you'll really get it.
Let this be another lesson to you: In hopes of appealing to kids and their families, some mutual fund groups have set up funds aimed at teaching children about investing. But what they're teaching may not turn kids into eager investors. An analysis by Standard & Poor's of these funds, plus funds that allow parents or others to set up irrevocable trusts for kids, found their return was minus 3.6 percent for this year through July versus a decline of 0.92 percent for the S&P 500 over the same period.
The ill wind that hit Florida has blown some good from the Internal Revenue Service. The agency is extending deadlines and offering other special relief to taxpayers in the disaster area created by Tropical Storm Bonnie and Hurricane Charley.
Taxpayers in 25 Florida counties generally will have until Oct. 15 to file tax returns and submit tax payments. The IRS will abate interest and any late filing or late payment penalties that would apply. Taxpayers who got an automatic extension to file their 2003 returns back in April would have had to file by last Monday or get another extension. Beneficiaries of this relief include individual taxpayers and businesses located in the disaster area, those whose tax records are (or were) there, and relief workers.
"Storm victims shouldn't be worrying about taxes at a time like this," Internal Revenue Commissioner Mark W. Everson said. "The special tax relief announced today will give people more time to file and pay their taxes."