One of the gray areas that the LCA curriculum does not cover is deducting the cost of MBA tuition for tax purposes. Every year in the United States, a select portion of MBA students deduct educational expenses including tuition and fees, books, equipment, software and miscellaneous school supplies on their tax returns. The result is the taxpayer saving thousands of dollars, oftentimes in excess of $5,000 in a given tax year.
Section 162 (§ 162) of the Internal Revenue Code allows deductions for “all ordinary and necessary expenses paid or incurred in the taxable year in carrying on any trade or business”. While § 162 does not explicitly cite educational expenses, § 1.162-5 of the Treasury Regulations outlines general guidelines under which educational expenses qualify as “ordinary and necessary” business expenditures under § 162. The deduction itself is a miscellaneous itemized deduction taken on Schedule A of Form 1040, speci cally line 21 “unreimbursed employee expenses”. To take the deduction, the taxpayer will attach Form 2106 “Employee Business Expenses” that will detail the educational expenses.
The 1971 case of Sherman v. Commissioner has set precedent for the MBA deduction. In the landmark case, the tax court
upheld Stephen Sherman’s (a Harvard MBA) case for deducting his graduate school educational expenses. Prior to Sherman’s case, the tax authorities maintained that suspending trade or business activity for longer than one year disquali ed a taxpayer from this deduction because that trade or business was no longer “ongoing”. After the case, the tax authorities dropped the “one year” rule on the de nition of “carrying on” a trade or business as long as the suspension was “temporary and de nite”. With most MBA programs representing a two year leave of absence, this ruling opened the door for future taxpayers to take advantage of the deduction.
To be eligible for the deduction, the taxpayer must meet three basic criteria. First, the MBA degree must be related to a trade or business which you are “carrying on”; hence, this criterion would disqualify all career switchers. Second, the MBA degree must not be the minimum educational requirement for your ongoing trade or business, nor can it qualify you for a new trade or business. This second part of this criterion is where the major gray area lies because of the versatility of the MBA degree. Tax professionals have often claimed that individuals with consistent work experience prior to schooling who can demonstrate that the curriculum had a “direct” and “substantial” relationship to the tasks performed on the job are the best candidates for the deduction. The argument here is that while the MBA makes
you more attractive for other industries, it does not necessarily “qualify” you for those new industries. Lastly, the MBA degree must maintain or improve skills needed in your profession.
Assuming you qualify for the MBA tax deduction, you will likely run into the Alternative Minimum Tax (AMT), which will reduce the tax bene t of the deduction. Basically, the AMT is a supplemental income tax that ensures taxpayers with signi cantexemptions and deductions still pay at least a minimum amount of tax (calculated as a at rate percentage on an adjusted amount of income above a certain threshold).
While tax planning is a time consuming process, for many MBA students thinking about various tax strategies can translate into real savings. It may be worth considering the conversion of retirement funds from a Traditional IRA to a Roth IRA or negotiating the timing of income related to sign-on or relocation bonuses in years with lower income. While this article does not cover the Lifetime Learning Credit, it may be an additional tax bene t available to MBA students seeking to optimize their tax situation.
The recent August 2016 case of Kopaigora vs. Commissioner, where the tax court upheld an Executive MBA student’s deduction is yet another win for graduate students seeking the deduction. While this issue will
continue to be debated among tax professionals, you may want to consider the deduction if you are eligible. As always, it is prudent to discuss your situation with a tax professional to discuss the nuances of the deduction and who can offer audit assistance in the event the IRS challenges your deduction claim.
Rob Monaco (HBS’18) enjoys a wide variety of professional interests including investing, entrepreneurship and behavioral economics. Prior to HBS, Rob worked in investment banking and private equity, and now hopes to apply his nance experience to a more global context, particularly to small business building and promoting education in the developing economies of Latin America where he enjoys spending time with his family.