MAcc versus MBA: can CPAs deduct the costs?
Many CPAs who graduated before the 150-hour requirement viewed passing the CPA exam as more important than pursuing a fifth year of college education. Today, many of those CPAs, who have gained expertise through work, continuing professional education, and on-the-job training, find that they want and need to upgrade their formal education. Many CPAs choose one of two routes: the Master of Business Administration degree (MBA), or the Master of Accountancy degree (MAcc).
Some would contend that the AICPA has promoted the MBA for CPAs. In 1989, the AICPA vice president for education, Rick Elam, stated that the Institute did not advocate more accounting education. In the 150 hours of required education, he suggested that one-third should be business oriented ("Meeting the New 150-Hour Standard: What CPAs Should Know About the New Requirement," by Stephen J. Collins, Journal of Accountancy, August 1989). In 1995, Elam suggested that college students headed for careers as accountants should have management and communication skills ["Serving Up an MBA with an Accounting Degree," by Paul Demery, The Practical Accountant, 28(7): 12, 1995].
According to Terrence L. Johnson, more than 90,000 MBA degrees were awarded in 1995, compared to 35,000 in 1974 ("Gaining the Executive Edge," Black Enterprise, May 1997). According to Jane J. Kim ("M.B.A. Students May Lose Tax Break," The Wall Street Journal, August 17, 2004), that number has continued to rise, with more than 120,000 MBA degrees conferred in 2002. CPAs may find the MBA attractive because it is readily obtainable in nontraditional modes such as evening, weekend, or online formats and because it offers expertise in areas beyond accounting. CPAs may find the MAcc degree attractive because of the specialization it offers and because it may be viewed as adding more value in an accounting-specific job. In addition, the MAcc may be regarded as more prestigious because of the ubiquity of MBAs. In 1980, the Master of Accounting credential was somewhat unfamiliar to many corporate accountants, and was accepted to a significantly lesser extent than other credentials such as the CPA and MBA ["A Survey of Corporate Controller Attitudes Toward Professional Certification and Master's Degree Programs," by John J. Anderson and James M. Krueger, Akron Business and Economic Review 11(2): 48, 1980]. While the number of master's degrees in accounting is small compared to MBA degrees, the number has increased significantly, from 3,145 in 1991 to 5,422 in 2002 ["Factors Affecting the Supply of Accounting Graduates," by Mary Jo Billiot, Sid Glandon, and Randy McFerrin, Issues in Accounting Education, 19(4): 443, 2004]. Although many corporations are willing to underwrite the costs of their CPA employees' obtaining graduate degrees, with executive development budgets tightening, many companies will pick up only a portion of the cost of postgraduate studies, and some require long-term employment commitments that include an agreement to repay the education costs if the commitment is broken.
Tax Incentives for Education Costs
Congress has given taxpayers several incentives that encourage higher education. The IRC contains various provisions for exclusions, deductions, or credits that are available to those pursuing an MBA or MAcc degree:
* IRC section 127 allows up to $5,250 of qualified employer-paid educational costs for undergraduate or graduate tuition, fees, books, and supplies to be excluded from the employee's taxable wages.
* Under IRC section 25A, taxpayers may be eligible for the lifetime learning credit for 20% of qualifying expenses of up to $10,000 per year.
* IRC section 222 allows a $4,000 above-the-line deduction for qualified tuition and related expenses.
* Most states have some type of college tuition prepayment program. Congress has created an income exclusion for the earnings used for qualified education costs under IRC section 529.
* The interest on Series EE U.S. government savings bonds (Coverdell education savings accounts) may be excluded from income under IRC section 135 if the proceeds are used to pay qualified higher-education expenses.
* IRC section 530 allows for a nondeductible contribution of $2,000 to an education IRA where investment income is excluded from taxable income and distributions to pay qualified higher-education costs are generally made tax-free.
* IRC section 162 allows an employee to deduct expenses incurred for education as an ordinary and necessary business expense under certain conditions.
Unfortunately, most of these incentives have restrictions:
* As income levels rise, several credits and deductions are phased out, making them unavailable to many CPAs.
* Taxpayers cannot "double-dip." An expenditure deducted or credited under one provision cannot also be taken as a credit or deduction under another provision.
* The provisions created by the Economic Growth and Tax Relief Reconciliation Act of 2001 expire in 2010.
* Specific criteria must be met for some provisions. For example, the IRC section 222 deduction is not available for taxpayers who choose the IRC section 25 credit for the tax year.
* Some provisions are not available to taxpayers who are married filing separately.
IRC Section 162 Provisions
In the past, IRC section 162 has been a popular way for CPAs to defray at least a portion of the costs of their graduate education. This provision permits employees to deduct expenses incurred for education as an ordinary and necessary business expense if the expenses are incurred for either maintaining or improving existing skills in their present job, meeting the express requirements of an employer or meeting legal requirements necessary to retain their employment status.
Many CPAs who take a deduction for expenses incurred in the pursuit of an MBA or MAcc degree do so with the intent of meeting the first criterion of improving existing skills in their present job. Treasury Regulations section 1.162-5 provides some clarification on the nonde-ductiblity of certain education costs. Although the education may maintain or improve skills required by an employer, education expenses under these two categories are specifically excluded as a deduction if--
* those expenditures are incurred for meeting the minimum educational standards for an existing job; or
* those expenditures qualify the taxpayer for a new trade or business.
The fact that a taxpayer is already performing service in an employment status does not establish that he has met the minimum educational requirement.
A drawback of deducting education expenditures under IRC section 162 is that they are classified as miscellaneous itemized deductions, and as such are deductible only to the extent that they exceed 2% of adjusted gross income, and are subject to a phase-out for higher-income taxpayers. Given these limitations, section 162 has been a very popular method for taxpayers to write off their education expenditures for several reasons:
* Although the deduction is subject to the 2% floor, it is not limited to a particular dollar amount.
* Education expenses deducted under section 162 are considered to be ordinary, necessary business expenses, and include not only books and tuition but also transportation and travel.
* A taxpayer can deduct any excess qualifying costs ineligible for a deduction or credit under another provision of the IRC.
* Even with the 2% limitation, this option may be more attractive than the $4,000 above-the-line deduction or the IRC section 25A credit because the phase-out for these incentives begins at a lower income level.
As stated, a CPA might rationalize the deductibility of the costs associated with pursuing either an MBA degree or a MAcc because either would presumably improve her skills. A CPA already in public practice or industry might argue that a MAcc is not a minimum educational standard for most accounting jobs and many business-related jobs, and would probably not qualify the CPA for a new trade or business. A CPA could also argue that an MBA is not a minimum educational standard, because many older senior executives do not hold an MBA degree ("A Little Learning Is a Dangerous Thing to Deduct," by Albert B. Crenshaw, The Washington Post, July 22, 2004). Whether obtaining an MBA qualifies a CPA for a new profession is not so easily determined. As discussed below, the deductibility under IRC section 162 of the education costs of obtaining an MBA has been challenged by the IRS and upheld by the U.S. Tax Court on the basis that the MBA qualifies the taxpayer for a new trade or business.
These decisions indicate that the IRS's position is that taxpayers already working in a business field will no longer be able to deduct the cost of obtaining an MBA under IRC section 162. Robert Willens, a tax and accounting expert at Lehman Brothers Holdings, Inc., speculates that those claiming the MBA deduction may be more susceptible to IRS audits, and suggests that it is becoming virtually impossible to take a deduction for education expenses (Kim, August 17, 2004).
Disadvantageous IRS Decisions and Court Rulings
Several recent IRS letter rulings and Tax Court decisions give the impression that the education costs of obtaining an MBA will not qualify as an IRC section 162 deduction. The IRS has challenged the deduction and the Tax Court has affirmed the disallowance where employees worked in a business setting, maintained management positions, and sought to improve their existing skills. In a 1986 letter ruling (Letter Ruling 8714064) and again in a Tax Court summary decision (TC Summary Opinion 2002-49), taxpayers were denied a deduction under IRC section 162 for educational costs to obtain an MBA degree. In both situations, the taxpayers left their jobs in business to pursue the MBA. The IRS agreed in both cases that the taxpayers' skills were maintained or improved by their course of study. However, the taxpayers were not required by their employers to obtain an MBA, and although the taxpayers did not intend to enter into a new career, the MBA qualified them to do so. Treasury Regulations section 1.162-5 specifically denies a deduction for educational costs that qualify the taxpayer for a new trade or business. Therefore the expenses were not "business expenses" as defined in section 162.
In 2003, the Tax Court upheld the IRS's decision to deny the deduction for an attorney's education expenses in pursuit of an MBA degree (TC Memo 2003-68). The taxpayer, who held an LLM in corporate finance, was advised to obtain a JD degree to increase his marketability in a competitive environment. Subsequently, he chose to extend his studies by one year in order to obtain joint JD/MBA degrees. Although the attorney had worked as a summer associate for law firms while he was a member of the state bar, the IRS contended that his assignments and compensation were similar to other full-time nonattorney associates and thus he had not established himself in his trade or business as a practicing attorney. The court reasoned that it was necessary to break the education cycle and engage in a trade or business before deducting education expenses.
In 2004, the IRS again denied a deduction for education expenses in the pursuit of an MBA degree by a financial analyst working in the investment banking industry (TC Summary Opinion 2004-107). In 1996, a financial analyst with a BA degree quit her job in the investment banking industry because of the long hours she had to work, and pursued an MBA full-time. To be promoted from "financial analyst" to "associate" in 1996, the investment banking industry required an MBA degree. Upon completion of her MBA the taxpayer took a position in the manufacturing industry in a "general management program" that required an MBA or equivalent. She argued that the expenditures were incurred to maintain and improve her skills and that the expenditures were required as a condition to the retention of an existing employment relationship. She focused on the similarities between her duties as a financial analyst and those of the associates at the investment banks firms where she had worked.
As in the previous cases, the deduction was denied on the basis that the MBA qualified the taxpayer for a new trade or business. Although the duties of analyst and associate overlapped, the analyst position was a subordinate temporary position lasting for a maximum of three years. The IRS contended that the fact the taxpayer was already performing service in an employment status did not establish that she had met the minimum educational requirements for qualification in that employment. In its decision, the court agreed with the IRS and cited Treasury Regulations section 1.162-5(b)(3), stating that the expenses were not deductible even though the taxpayer did not intend to enter a new field of endeavor, and even though the taxpayer's duties were not significantly different after the education from what they had been before the education.
Issues to Consider
A graduate degree can be an important asset to older CPAs competing with the new generation of CPAs who are entering the workforce holding MBAs or MAccs. A CPA who wishes to deduct the cost of a graduate degree under IRC section 162 should consider several issues. The IRS may challenge a CPA on the cost of obtaining a MBA or MAcc on the grounds that it prepares the CPA for a new trade or business. Whereas the MBA appears to be nondeductible, will the IRS and courts recognize the MAcc as simply an improvement of skills for the CPA? If a CPA quits a job and returns to school full-time, will the IRS and courts view this as a temporary suspension of employment, or as preparation for a new career?
Acquiring a graduate degree is costly, and taxpayers should take advantage of any legal means to minimize that cost. Most taxpayers would agree with Judge Learned Hand's observation in his 1947 court ruling (Comm'r v. Newman):
Over and over again courts have said that there is nothing sinister in so arranging one's affairs as to keep taxes as low as possible. Everybody does so, rich or poor; and all do right, for nobody owes any public duty to pay more than the law demands: taxes are enforced extractions, not voluntary contributions.
Based on recent IRS rulings and court decisions, however, taxpayers may have lost the power to obtain an IRC section 162 tax deduction for the cost of obtaining an MBA degree. It appears that it will be very difficult to get the deduction, and MBA students who claim the deduction should be prepared for an IRS audit. Will CPAs see the MBA degree as a benefit to their professional career that surpasses the additional costs resulting from their inability to deduct their expenses? Or will they determine that the MAcc provides a comparable benefit, and one that satisfies the IRC section 162 regulations?
Patricia H. Mounce, PhD, CPA, is an associate professor of accounting, and Pamela A. Spikes, PhD, CPA, is a professor of accounting, both at the University of Central Arkansas, Conway, Ark.
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|Title Annotation:||personal financial planning|
|Author:||Mounce, Patricia H.; Spikes, Pamela A.|
|Publication:||The CPA Journal|
|Date:||Mar 1, 2006|
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