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EDUCATION IS ITS OWN REWARD (WHEN THERE'S NO TAX DEDUCTION)

July 11, 2003

"Furthermore, a general college education has more than economic utility. It broadens one's understanding and increases his appreciation of his social and cultural environment." Tax Court Judge Simpson, 1964

The broad understanding and increased appreciation are nice things, certainly, but on April 15, many folks would just as soon have the one thing that a general college education doesn't provide -- a tax deduction.

The tax law prohibits deductions that can train you for a new job. By contrast, "continuing" education to improve your skills for the job you already have are deductible. Two recent cases show how the Tax Court distinguishes "continuing" and "general" education.

NO DEDUCTION: YOU LEARNED TOO MUCH

George Warren was in his 40s when he felt called to the ministry in the United Methodist Church. He qualified to be a part-time local pastor by 1993. He decided he needed to hone his skills, so he began taking additional courses that led to a bachelors degree. He took a deduction for the educational expenses. The Tax Court gave him the bad news:

"We conclude that the courses, which ultimately led to petitioner's bachelor's degree, qualified petitioner in a new trade or business. The courses taken by petitioner provided him with a background in a variety of social issues that could have prepared him for employment with several public agencies and private non-profit organizations outside of the ministry. Whether or not petitioner remains in the ministry is irrelevant; what is important under the regulations is that the degree "will lead" petitioner to qualify for a new trade or business."

In other words, courses have to be helpful for your new job, but they can't qualify you to do anything else. Go figure.

GRAD STUDENTS FOLLOW THE SAME RULES

Yuanqiang Zhang, a Chinese national, worked in the Andersen Consulting office in Beijing from January 1997 to June 1999. He left Andersen Consulting to get an MBA at the MIT Sloan School. Upon graduation he took a position with Morgan Stanley in New York.

When the taxpayer attempted to deduct about $30,000 of MIT tuition on his 2000 Tax Return, the IRS balked. The Tax Court sided with the IRS on the grounds that you can't be improving skills for your current job when you are between jobs.

WHAT CAN YOU DEDUCT?

Traditional continuing education courses, such as those required for licensed professionals, are deductible; if you are filing on a Schedule C, or are a partner - for example, in a law or accounting firm - they are deductible in full. If you are an employee, they are deductible on Schedule A, subject to the 2% of AGI floor on miscellaneous itemized deductions.

WHAT CAN YOU EXCLUDE?

If your employer is paying your educational expenses directly, you can generally exclude up to $5,250 of the payments from income each year. This is often a better deal than a deduction - not only do you avoid the 2% of AGI floor, but you can exclude employer-paid "general" course tuition from income, even though you could not deduct it if you paid it yourself. The employer payments have to be under a "qualified" program that does not discriminate in favor of highly-compensated employees.

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