SMITH BRAIN TRUST — A recent tax court overruling of the Internal Revenue Service marks “a big win for all MBA students” — according to a Wall Street Journal source in a report further stating that the case "should embolden more students enrolled in MBA programs across the country to deduct their tuition — especially if they are getting an executive MBA." But accounting professor Samuel Handwerger at the University of Maryland’s Robert H. Smith School of Business says not so fast. "MBA students should not automatically expect the IRS to back off on its scrutiny over tuition deductions," he says.
The case, Kopaigora v. Commissioner, "represents the latest in a history of cases where the IRS looks at the MBA with a jaundiced eye, but mostly loses in tax court, where judges tend to take a more liberal view of deductible education expenses than that of the IRS," Handwerger says. Judgments favoring taxpayers, such as Daniel R. Allemeier, TC Memo 2005-207 from 2005 and Singleton-Clarke, TC Summary Opinion 2009-182 from 2009, have not swayed the IRS to liberalize its own view. A 2010 WSJ blog post suggested that this 2009 case "may open the floodgates to MBA deductibility." But Handwerger says: "In 2016, the IRS has not given up the ship."
Broadly, the Internal Revenue Code allows taxpayers to deduct MBA tuition as "unreimbursed business expenses" provided that it improves skills in a present trade or business — but not if the education leads to a new type of job or a professional license.
In Alex Kopaigora’s case, the IRS denied his $18,879 tuition deduction that would have saved him $2,111 in taxes, determining that he lost his job as a hotel manager while pursuing an executive MBA degree that prepared him for a different line of work (small business consultant). The court disagreed, ruling that Kopaigora’s job dismissal did not remove him from being in the trade of management and that his pre- and post-MBA work aligned sufficiently. Forbes details Kopaigora’s story here.
"A key element here that bothered the IRS, and one that has bothered them on more than one occasion, was the temporary leave of absence from a job," Handwerger says. "For an expense to be deductible and not personal, one has to be in the 'business.'" The IRS has, though, recognized "temporary absences" on two fronts: First, taxpayers return to the employer or trade for which the education was designed to help improve their skills, Handwerger says. "The tax court has, heretofore, expanded this to where the key determinant appears to be whether the taxpayer intends to return to employment in the same trade or business." He cites Haft v. Comm., 1963, as an example.
Secondly, the IRS has long considered a temporary absence to be defined as a period of one-year or less. (See Rev Rul 68-591). "So in the Kopaigora case, the IRS apparently was bothered that this taxpayer was not on the job and pursuing an education for a period of just beyond that one-year period, as he stopped working in April of one year, and was not hired until September of the following year," Handwerger says.
Further reflecting both fronts, the Kopaigora case’s length-of-time element appears nullified by the judge asserting Kopaigora was terminated unjustly. And, the ruling suggests, he returned to the same 'business' even though the judge distinguished his finance coursework as outside the scope of improving his "management" skills.
Handerwerger says the WSJ suggestion that the case is significant for executive MBAs is offset by MBA-executive MBA coursework similarity. "I do not see the distinction — especially in this case," he says. (Separately, executive MBAs might be more exposed to the Alternative Minimum Tax, with its $83,400 income threshold for taxpayers filing jointly. Where the AMT applies, taxpayers lose this tuition deduction altogether).
Smith School Associate Dean of Executive Programs Gary Cohen says he doesn’t see the IRS approach to tuition deduction — as illustrated in the Kopaigora case — shaking up executive MBA programs. "Many of these students may not be aware of the scope of this issue," he says. "However, reduced IRS scrutiny of tuition deductions would be a welcome improvement to the EMBA value proposition and could enhance enrollment."
Handwerger expects the IRS to remain stubborn. "After a string of losses in this area, you would expect the IRS to give in, but given the history they will likely continue the battle," Handwerger says. "Taxpayers deducting MBA costs should continue to anticipate being challenged by the IRS, on audit, looking to at least cherry pick courses they would accept as being deductible."
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