Can MBA Costs Be Deductible?
As an employee or self-employed individual, can you deduct the cost of getting a Masters in Business Administration (MBA) degree? Good question.
The answer usually depends on whether the degree maintains or improves skills needed in your current business or profession, or instead prepares you for a completely new business or profession. One U.S. Tax Court decision illustrates this point.
Before getting to that decision, let’s cover the basics on what it takes for employees and self-employed individuals to deduct education costs as a business expense.
Basics on Business Education Deductions
For federal tax purposes, the general rule for an individual taxpayer’s work-related education expenses is that you can deduct them as business expenses.
If You’re an Employee
If the education relates to your business of being an employee, the write-off is categorized as a miscellaneous itemized deduction for unreimbursed employee business expenses. However, you can only write off miscellaneous itemized deductions to the extent they exceed 2 percent of adjusted gross income (AGI). Other common expenses that fall into the miscellaneous itemized deduction category include investment expenses, fees for tax preparation and advice, and union dues. So, if you have some of these expenses, you can combine them with your education expenses and improve the odds of exceeding the 2-percent-of-AGI threshold. (AGI is the number at the bottom of page 1 of your Form 1040. It includes all taxable income items and certain deductions such as the ones for deductible IRA contributions, alimony paid and moving expenses.)
Unfortunately, the 2-percent-of-AGI threshold often precludes any write-off, unless your education expenses add up to a relatively big number. Of course, the costs of obtaining an MBA degree often do add up to a big number. So keep reading.
If You’re Self-Employed
When your education expenses relate to a self-employed business activity, you don’t have to worry about the 2-percent-of-AGI threshold. Instead, you can claim 100 percent of business-related education costs on Schedule C (for sole proprietors), Schedule E (for partners, LLC members and rental activities) or Schedule F (for farmers and ranchers).
What Does It Take for Education Expenses to Be Work-Related?
Now it starts to get a bit complicated. For education expenses, including MBA costs, to be considered work-related (and therefore deductible), you must pass at least one of two qualification tests and also avoid two disqualification rules.
Qualification Test No. 1: The education is expressly required by your employer or required by applicable law or regulations in order for you to retain your current employment relationship, status or compensation level (in other words, your current job).
Qualification Test No. 2: The education maintains or improves skills required in your current job, business or profession.
Disqualification Rule No. 1: You cannot deduct as a business expense the cost of schooling that’s required to meet the minimum educational requirements for your job, business or profession. In 2005, the Tax Court clarified that this disqualification rule is mainly intended to apply to education that’s required in order to be hired for a current job or education that must be obtained within a certain period of time after being hired in order to retain a current job. In other words, the education is basically a prerequisite for your current job. (Daniel Allemeier Jr., T.C. Memo 2005-207) In contrast, Qualification Test No. 1, which initially seems similar, is intended to apply to education that becomes required after you are already permanently ensconced in your current job.
Disqualification Rule No. 2: You cannot deduct, as a business expense, education costs for a program of study that trains you for a new business or profession (including being an employee in a new profession). According to several Tax Court decisions, education that prepares a taxpayer for a new business or profession falls under Disqualification Rule No. 2, even when the taxpayer doesn’t actually intend to enter the new field or profession. The Tax Court has also opined that education that trains you for a professional certification or license (such as law school or medical school) will almost always be deemed to train you for a new profession and is therefore generally non-deductible — even if you have no intention of actually practicing that new profession. One common application of this rule is when a person goes to law school but doesn’t intend to work as a lawyer.
In the case of an employee, the IRS admits a change of duties does not constitute a new business or profession if the new duties involve the same general type of work as the employee’s present duties.
For example, getting promoted to a new job in the same general field of finance or marketing doesn’t constitute entering a new business or profession. So, if you get a promotion in the same general field or line of business after obtaining an MBA degree, you have not run afoul of Disqualification Rule No. 2. Therefore, you can deduct MBA costs if the education maintains or improves skills needed in your current general field or line of business — assuming your employer doesn’t require the MBA as a minimum educational requirement to get or keep your promotion (Disqualification Rule No. 1).
Unfavorable Tax Court Decision
In one Tax Court case, the taxpayer, Adam Hart, began an MBA program in 2009 while he was employed as a pharmaceutical salesman. During his time in the program Hart also held positions as an account manager for a payroll company and as an entry-level worker for a drug store chain. In addition, he was unemployed for part of the time. On his 2009 federal tax return, Hart claimed an unreimbursed employee expense deduction for $18,600 of MBA tuition costs. The IRS disallowed the deduction and Hart took his case to Tax Court. Unfortunately for him, the court agreed with the IRS on the grounds that:
1. Hart’s employers didn’t require him to enroll in an MBA program.
2. He was not actually established in a job, business or profession in 2009. Therefore, he could not claim that the MBA costs were incurred to satisfy an employer requirement (Qualification Test No. 1) or that they were incurred to maintain or improve skills needed in his current job, business or profession (Qualification Test No. 2). (Adam Hart, TC Memo 2013-289)
Earlier Favorable Tax Court Decisions
Some commentators have incorrectly characterized the Hart decision as standing for the general proposition that MBA costs simply cannot be deducted as business expenses. Not true. In fact, the Tax Court has repeatedly ruled in favor of taxpayers on this issue.
In a 2009 decision, the court concluded that a registered nurse could deduct costs incurred to obtain an MBA with a specialization in health care management. The taxpayer worked in various capacities, including as a director of nursing for a long-term care facility. While the MBA improved her preexisting skill set, she was already performing the tasks and activities of her current profession before, during and after she entered the MBA program. So, the MBA education satisfied Qualification Rule No. 2 without running afoul of Disqualification Rule No. 2. (Lori Singleton-Clarke, T.C. Summary Opinion 2009-182)
In a 2005 decision, the court ruled that the taxpayer’s MBA costs qualified as deductible business expenses because the degree wasn’t required to satisfy minimum educational standards for his existing job (Disqualification Rule No. 1) and it did not qualify him for a new business or profession (Disqualification Rule No. 2). Instead, the MBA program simply improved the taxpayer’s preexisting capabilities in his existing field of marketing (Qualification Rule No. 2). The taxpayer remained a full-time employee while pursuing the MBA, and was promoted several times during that period. However, an MBA wasn’t required by his employer and the basic nature of his duties (marketing-related activities) didn’t significantly change after he got the degree. (Daniel Allemeier Jr., T.C. Memo 2005-207)
In a 1980 decision, the taxpayer was allowed to deduct MBA expenses incurred while he worked as a personnel professional. The MBA courses improved his job skills but did not qualify him for a new business or profession, even though he was promoted to the higher position of personnel manager. (Frank Blair III, TC Memo 1980-488)
In another 1980 decision, the court ruled that a NASA guidance systems engineer could deduct MBA expenses because the education provided him with a broad general background in management and business administration, which were already part of his existing work duties. (Robert Beatty, T.C. Memo 1980-196)
It may seem that MBA costs are almost never deductible as business expenses, but the opposite is true. Because MBA programs, by their nature, provide broad and general training, the costs are usually deductible as business expenses on the grounds that the courses maintain or improve skills needed in your current business or profession. Getting promoted to a higher position in the same general field or line of business doesn’t change that fundamental truth. However, if you haven’t yet become established in a business or profession, your MBA expenses are non-deductible. For example, you’re out of luck if you go straight from college into an MBA program without first establishing a career. You’re also out of luck if your employer requires an MBA degree as a precondition for obtaining or retaining your present job. Of course, these situations tend to be the exception rather than the norm.
If you have questions about the deductibility of MBA costs or want more information on the subject, consult with your tax advisor.