Thursday, May 19, 2016

Feel Free To Get A Law Degree, But Don't Plan On Deducting The Tuition


When you make your hay in a career as mundane as tax preparation, it’s common to spend your darker days hanging on to the hope that with one small change, you’ll be able to move on to something more exhilarating. Lose ten pounds and you’ll be an underwear model. Get that scuba certification and you’ll unearth sunken treasure on your next vacation  Go back to law school and you’ll soon deliver impassioned closing arguments that will leave witnesses confessing their guilt to an astonished jury. It all beats cranking out another Form 1065.
But losing weight is hard. Scuba certification is expensive. Any getting a law degree, well…that’s both hard and expensive, and truth be told, a tax pro getting a law degree is far less likely to lead to a career as defense attorney to the stars as it is to leading right back to a career as a tax professional. Only one with a lot more debt. And that stings.
So if you’re a tax pro who shells out $100K only to become a deeper-in-debt tax pro, you should at least get a tax deduction for your tuition, no? After all, the degree has undoubtedly strengthened your knowledge of the tax law and thus enhanced your ability as a professional. But is that enough?
To understand the answer, consider the case of Emmanuel Santos. Santos owned an undergraduate degree in accounting and a career as an enrolled agent preparing tax returns, but he wanted more. He went back to school and earned a masters degree in taxation – which allowed him to expand his practice to accounting work and financial planning – but still, he wanted more. So he went to law school, passed the bar, and started a law firm focusing on tax planning. Santos was also admitted to practice before the Tax Court. which would soon come in handy on a very personal level.

On his tax return for 2010, a year in which Santos was in law school, he reported the income from his tax preparation business on Schedule C. He also reported $22,000 of law school tuition as a deductible expense. The IRS denied the tuition deduction, Santos sued, and the issue landed both parties in the Tax Court, where Santos represented himself.
Deductible Tuition Expenses
Section 162 permits a deduction “for all ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business.” Section 262, however, adds that no deduction is allowed for personal, living, or family expenses. So which category do tuition expenses find themselves in? Are they deductible business expenses? Or nondeductible personal expenses?

The answer, as is often the case in the tax law, is it depends. The general rule is that tuition expenses are considered nondeductible personal expenses unless they meet an exception provided for in the Section 162 regulations. Those regulations permit a deduction for education expenses in two scenarios; when the education:
(1) maintains or improve skills required by the taxpayer in his or her employment or
(2) meets the express requirements of the taxpayer’s employer, or of applicable law or regulations, imposed as a condition to the retention by the taxpayer of an established employment relationship, status, or rate of compensation.
While that sounds promising, particularly  in the case of Santos, who could justifiably claim that his law degree “maintained or improved skills required in his employment,” there is an additional hurdle. The regulations go on to provide that there are specific types of tuition expenses that are NOT deductible, including:
Education that is part of a program of study which will lead to qualifying the taxpayer for a new trade or business. 
That’s where thing get interesting. Santos was a tax guy before his law degree, and a tax guy afterhis law degree. He didn’t suddenly transition from Louis Tully to Matlock. So couldn’t the argument be made that the law degree, in this case, did not ready him for a new trade or business?
It probably could, but it would, and did, fail. And it failed because the regulations use the word “qualify,” as in, did the law degree free you to do things you couldn’t do before, even  if  you didn’t take advantage of those new options? An example in the regulations makes clear that a law degree will always qualify you for a new trade or business, by stating,
 “A, a self-employed individual practicing a profession other than law, for example, engineering, accounting, etc., attends law school at night and after completing his law school studies receives a bachelor of laws degree. The expenditures made by A in attending law school are nondeductible because this course of study qualifies him for a new trade or business.”
The courts have sided with this interpretation, holding that the critical factor is that a law degree qualifies you for a new business, even if you aren’t aiming to make a change. In O’Donnell v. Commissioner, 62 T.C. 781 (1974), the Tax Court concluded that a CPA could not deduct his law school tuition, even though he undertook the education to improve his accounting and tax skills, and had no intention of ever practicing law, because he could have had  he wanted to.
Santos attempted to argue that the regulations were invalid, but the court quickly dismissed this notion.
So miserable tax preparers of America, feel free to flee the industry and pursue your dreams. But understand that any tuition you pay to prepare you for that new life is not deductible. Of course, given  your history as a tax preparer, you probably  should have already known that.