There are two types of education- one that is open-ended and has no business connection to your trade or profession, and one that helps you improve a current work skill.
Open-Ended Education Assistance
The Age 21 rule stems from attribution rules whereby a child under the age of 21 is deemed to own the same percentage as his or her parents. So, if you own 100% and your child is 20, your child is considered to be a 100% owner for this benefit (and many others), which obviously exceeds the 5% rule.
For your amusement, 26 USC 1563(e) Constructive Ownership reads-
(6) Children, grandchildren, parents, and grandparents
And, 26 USC 127(b) Educational Assistance Programs-
(3) Principal shareholders or owners
So, your kids essentially (a) have constructive ownership until 21 year of age, (b) are considered a 5% shareholder and (c) are ineligible for education assistance. And as mentioned through this book, special rules kick in for a 2% shareholder (or 5% shareholder in this case) triggering tax consequences for benefits received. Therefore the benefit might kick in around senior year in undergraduate school, and certainly for any graduate or post-degree education.
Under Section 127, reimbursable education includes any form of instruction or training that improves or develops the capabilities of an individual, and is not limited to job-related or degree programs. However, qualified expenses do not include meals, lodging and transportation.
A written plan must be drafted and employees must be notified of the benefit. Therefore we suggest having each employee sign a notice that explains the benefits, and that they have read and understand the benefits. And no other benefits can be offered as an alternative- in other words, you cannot provide additional pay or bonus for employees who do not use the educational assistance program.
Improving Current Work Skills
So, can you deduct your MBA? Perhaps. In Lori A. Singleton-Clarke v. Commissioner, Tax Court Summary Opinion 2009-182, the court ruled in Lori’s favor. She was an established nurse, and she went back to school to obtain an MBA in Health Care Management. She was already in charge of quality control from a management perspective, and the MBA did not lead to an additional and discernable skill. Additionally the court stated that the MBA improved her current work skill as a quality control coordinator. Subtle difference.
Here are some more-
Mary Colliver v. Commissioner, Tax Court Summary Opinion 2017-93. Mary held a Bachelor’s degree in speech pathology and was offered a position with a hospital doing similar work. The hospital position required Mary to obtain her Master’s degree in speech pathology, but the hospital allowed her to complete her studies while performing the tasks of the position. Specifically the Master’s degree allowed her to be a medical speech pathologist.
Mary subsequently deducted about $8,500 in qualified education expenses, and upon examination the IRS disallowed the deduction. The Tax Court also agreed and their summary concluded that the tasks and activities before and after the additional education were different enough to qualify as a new trade or business. In other words, Mary could not work in hospitals without the Master’s degree, and her education allowed her to do so. The Court found this convincing enough to deny the qualified education expense deduction.
Our take is that this is certainly splitting hairs. Mary was a speech pathologist before and after, and she simply improved her current work skills as a speech pathologist to become a better one. It wasn’t like she was a high school counselor who wanted to become a medical speech pathologist. So, be wary that the Tax Court is creating very low thresholds for making the leap of “new trade or business.”
Here’s another, similar crummy deal in our opinion-
Czarnecki v. U.S., 120 AFTR 2d 2017-5372. Jerry Czarnecki was an engineer for most of his adult life and held a Bachelor’s degree in engineering and a Master’s degree in applied mathematics. In 1998 he started a Doctoral program at MIT. Yeah, total nerd, ridiculously smart and probably super rich. Calm down ladies, we’re sure he had a third eye and was married with a gaggle of unruly children who would drive you nuts.
In 2007 he started to work for the U.S. Navy as a Systems Engineer Level 3 ensuring that submarines wouldn’t crumple under water and to study the effects of submarine vibration on batteries. Again, super high tech stuff. During 2010 he was a licensed professional engineer but was not as a structural engineer. Jerry deducted $8,712 in qualified education expenses on his 2010 amended tax return (first mistake… give an IRS human a reason to say, “yeah right.”).
His second mistake was not demonstrating how his Doctoral studies improved his current work skills. The Court said it was not enough to simply make the assertion as a global argument; the Court wanted very specific links between what Jerry did today and how his education improved his current set of skills.
As a result his deduction was disallowed
Before you drop $50,000 a semester for Wharton or Stanford, be careful. In our experience there is enough case law on either side of the MBA deduction issue to be wary. Having said that, get an MBA because you want the education, degree and ultimately more opportunities. If we can find a way to deduct it, great. If not, you still have improved yourself.
Taxpayer's Comprehensive Guide to LLCs and S Corps : 2019 Edition