LETTING THE HORSE OUT OF THE BARN: A PROPOSAL TO TREAT EDUCATIONAL EXPENSES LIKE OTHER BUSINESS EXPENSES

Transcription

1 LETTING THE HORSE OUT OF THE BARN: A PROPOSAL TO TREAT EDUCATIONAL EXPENSES LIKE OTHER BUSINESS EXPENSES DAN SHEAFFER * TABLE OF CONTENTS I. INTRODUCTION II. REGULATION AND THE HISTORY OF EDUCATIONAL... EXPENSES UNDER SECTION A. The History of Educational Expenses Under Section B. The Current Regulation C. The New-Trade-or-Business Test III. FUNDAMENTAL FLAWS WITH REGULATION A. The Inconsistent Treatment of Educational Expenses Subjective vs. Objective MBA Expenses An Arbitrary Line Summary of the Test B. Equal Treatment for Trade-or-Business Educational Expenses IV. PROPOSED AMENDMENTS TO REGULATION A. Getting Back to the Facts B. The New-Trade-or-Business Presumption C. Defining New Trade or Business V. CONCLUSION I. INTRODUCTION Section 162 of the Internal Revenue Code has been referred to as the business deduction workhorse of the Code. 1 The provision has rightfully earned such a reputation. Section 162 generally authorizes * Dan Sheaffer is a Professor of Law at the Thomas M. Cooley Law School. Professor Sheaffer graduated magna cum laude from the Thomas M. Cooley Law School and also received an LL.M. in Taxation from the University of Florida. He was a managing editor for the University of Florida s Florida Tax Review and also served on the Thomas M. Cooley Law Review. Prior to joining the Thomas M. Cooley faculty in 2004, Professor Sheaffer worked in private practice, as in-house tax counsel for a multinational corporation, and for a Big Four accounting firm. 1. J. MARTIN BURKE & MICHAEL K. FRIEL, TAXATION OF INDIVIDUAL INCOME 232 (9th ed. 2010).

2 248 THOMAS M. COOLEY LAW REVIEW [Vol. 28:2 any type of business 2 to deduct any type of expenses 3 that are ordinary and necessary to the particular trade or business. 4 The purpose of the provision is to ensure that businesses are taxed on their net income, not gross income. 5 This purpose is generally accomplished in an evenhanded manner. Section 162 does not generally result in particular industries or particular types of expenses receiving more or less favorable treatment than other types of businesses or expenses 6 that is, of course, unless the business expenses are educational expenses. Treasury regulations impose additional restrictions on the deductibility of educational expenses that do not apply to other types of business expenses. 7 As a result, when it comes to educational expenses, the Section 162 workhorse has a hard time getting out of the barn. When the workhorse does find its way out of the barn to cultivate educational expenses, it is difficult to predict the results that it will achieve. 2. Even taxpayers engaged in illegal businesses are allowed to deduct those expenses that are ordinary and necessary to such illegal business. See Comm r v. Sullivan, 356 U.S. 27, (1958) (allowing an illegal bookmaking business to deduct the cost of salaries and rent). But see I.R.C. 280E (2006) (disallowing deductions or credits for amounts incurred in carrying on drug trafficking). 3. See, e.g., Christine v. Comm r, 99 T.C.M. (CCH) 1591, (2010) (allowing a sports writer a deduction for the cost of horse-racing publications); Topping v. Comm r, 93 T.C.M. (CCH) 1120, 1125 (2007) (allowing a home and barn designer a deduction for the cost of an equestrian competition when most of her clientele was engaged in equestrian activities); Erhard Seminars Training v. Comm r, 52 T.C.M. (CCH) 890, 917 (1986) (allowing a company in the business of providing behavior-modification seminars a deduction for the cost of wilderness trips); Rev. Rul , C.B. 31 (allowing a company in the business of selling homesites a deduction for the cost of life-insurance premiums on the life of purchasers of homesites). 4. Section 162 provides that [t]here shall be allowed as a deduction all the ordinary and necessary expenses paid or incurred during the taxable year in carrying on any trade or business. I.R.C. 162(a) (2006). 5. BURKE & FRIEL, supra note 1; see also JOEL S. NEWMAN, FEDERAL INCOME TAXATION: CASES, PROBLEMS AND MATERIALS (4th ed. 2008). 6. Compare Palo Alto Town & Country Vill., Inc. v. Comm r, 565 F.2d 1388, (9th Cir. 1977) (allowing a deduction for maintaining an airplane on a standby basis when the taxpayer could show cost and time savings), with A.S. Barber, Inc. v. United States, No. N83-130C, 1984 WL 34771, at *2 (E.D. Mo. Dec. 26, 1984) (denying a dental corporation a deduction for the cost of operating a plane to fly dentists to assist in clinics when the practice had flown only four dentists to clinics in the past). 7. See infra notes 8 9 and accompanying text.

3 2011] EDUCATIONAL EXPENSES 249 The major impediment to the Section 162 workhorse getting out of the barn and being applied fairly to education-related business expenses is the new-trade-or-business test under Treasury Regulation Under the new-trade-or-business test, a taxpayer is denied a deduction under Section 162 if the expenses were for education which is part of a program of study being pursued by him which will lead to qualifying him in a new trade or business. 9 If education qualifies a taxpayer in a new trade or business, the taxpayer s deduction is denied regardless of whether the taxpayer actually enters the new trade or business. This is not the first article to question the wisdom and fairness of Regulation (the Regulation). Commentators have provided differing critiques of the Regulation with varying proposed solutions for over thirty years. 10 Some articles have addressed the overall inequity the Regulation has created, 11 while others have addressed the application of the Regulation in relation to specific types of educational expenses See Jay Katz, The Deductibility of Educational Costs: Why Does Congress Allow the IRS to Take Your Education So Personally?, 17 VA. TAX REV. 1, 3 4 (1997); James L. Musselman, Federal Income Tax Deductibility of Higher Education Expenses: The Good, the Bad, and the Ugly, 35 CAP. U. L. REV. 923, (2007); Marcus Schoenfeld, The Educational Expense Deduction: The Need for a Rational Approach, 27 VILL. L. REV. 237, (1982). 9. Treas. Reg (b)(3)(i) (as amended in 1967). 10. See John J. DeBoy, Solving the B-School Tax Riddle: A Proposal to Clarify the Confusion Surrounding Deductions for MBA-Related Educational Expenditures Under 162 of the Internal Revenue Code, 97 GEO. L.J. 1689, 1713 (2009); Vincent G. Kalafat, Rethinking Treasury Regulation and Slaying the Monster in the Education Tax Maze, 80 NOTRE DAME L. REV. 1985, (2005); Katz, supra note 8; Musselman, supra note 8, at 978, 981; Eugene Poverni, The [Mis]treatment of Professional Degrees as Non-Deductible Personal Expenditures, 19 FED. CIR. B.J. 461, (2009); Jill Kutzbach Sanchez, The Deductibility of MBA Degree Expenses Under Treasury Regulation : Are You One of the Lucky Few Who Qualify?, 32 J. CORP. L. 659, (2007); Schoenfeld, supra note 8, at See, e.g., Musselman, supra note 8, at 978 (arguing that there is no basis for the IRS to treat educational expenses as personal expenses); Schoenfeld, supra note 8, at 311 (arguing that Regulation is not a reasonable interpretation of Section 162(a)). 12. See, e.g., Poverni, supra note 10, at (examining the treatment of professional degrees); Sanchez, supra note 10, at (arguing that MBArelated expenses should not be deductible under Regulation ).

4 250 THOMAS M. COOLEY LAW REVIEW [Vol. 28:2 It is the position of this Article that Regulation has two fundamental flaws that need to be addressed. First, the Regulation results in denying deductions to taxpayers for educational expenses regardless of the relationship the expenses have to the taxpayers current trade or business. 13 Taxpayers incurring other types of expenses are almost universally allowed to at least attempt to demonstrate that the expenses at issue are ordinary and necessary in relation to their current business. 14 In contrast, once it is established that educational expenses qualify a taxpayer for a new trade or business, the Section 162 deduction is denied. 15 This denial takes place without an examination of the relationship that the educational expenses have with the current trade or business. 16 The unequal treatment of educational expenses puts taxpayers who grow or maintain their businesses through additional education at a disadvantage compared to taxpayers who incur other types of business-related expenses. The second fundamental flaw with the Regulation is the lack of guidance and definition as to when education is part of a program that qualifies a taxpayer for a new trade or business. 17 The Regulation provides examples that relate to the new-trade-or-business test but provides very little guidance for determining when education qualifies a taxpayer for a new trade or business. 18 Further, the little guidance that the Regulation does provide is internally inconsistent. The lack of consistent guidance and definition surrounding the newtrade-or-business test has led to inconsistent 19 and seemingly arbitrary results among varying types of educational expenses See, e.g., Lewis v. Comm r, No S, 2002 WL (T.C. May 7, 2002) (holding that the fact that the taxpayer s duties were not changing after obtaining an MBA was not relevant); Gates v. Comm r, 36 T.C.M. (CCH) 970 (1977) (holding that the taxpayer s individual circumstances are not relevant to whether his educational expenses are deductible); O Donnell v. Comm r, 62 T.C. 781 (1974) (holding the taxpayer s intent was not relevant under the new-trade-orbusiness test). 14. See discussion infra Part III.B. 15. See discussion infra Part III.B. 16. See Lewis, 2002 WL ; Gates, 36 T.C.M. (CCH) 970; O Donnell, 62 T.C. at See Treas. Reg (b)(3) (as amended in 1967). 18. See (b)(3)(ii). 19. See infra Part III.A See infra Part III.A.1 2.

5 2011] EDUCATIONAL EXPENSES 251 The goals of this Article are to highlight and demonstrate the flaws of the current Regulation and propose changes to address those flaws. Part II of this Article briefly discusses the history of educational expenses under Section 162 and the current Treasury Regulation. Part III highlights and demonstrates the fundamental flaws of the current Regulation by examining various cases. In Part IV, this Article offers proposed amendments to the current Regulation that directly address the identified flaws with the newtrade-or-business test. This Article provides concluding comments in Part V. II. REGULATION AND THE HISTORY OF EDUCATIONAL EXPENSES UNDER SECTION 162 A. The History of Educational Expenses Under Section 162 It would be reckless to suggest changes to the current Regulation without fully understanding and exploring the history of how educational expenses were treated under Section 162 prior to the adoption of the current Regulation. Educational expenses were historically treated as nondeductible personal expenses by the IRS 21 and the courts. 22 However, a 1950 United States Court of Appeals for the Fourth Circuit decision changed the course of this treatment. 23 In Hill v. Commissioner, the Fourth Circuit reversed the Tax Court and held that a teacher s expenses associated with attending summer school were not personal expenses, but rather deductible business expenses. 24 The taxpayer in Hill, a teacher with over twenty-five years of experience, was taking summer courses at Columbia University to maintain her teaching 21. In an Office Decision from 1921, the IRS took the position that expenses incurred by school-teachers in attending summer school are in the nature of personal expenses incurred in advancing their education and are not deductible in computing net income. T.B.R. 892, 4 C.B. 209 (1921); see also T.B.R. 894, 5 C.B. 171 (1921) (holding that expenses incurred by a doctor for post-graduate classes were nondeductible personal expenses). 22. See, e.g., Darling v. Comm r, 4 B.T.A. 499 (1926) (disallowing a professional cartoonist a deduction for art classes); see also Musselman, supra note 8, at Hill v. Comm r, 181 F.2d 906 (4th Cir. 1950). 24. Id. at 911.

6 252 THOMAS M. COOLEY LAW REVIEW [Vol. 28:2 certificate. 25 The Tax Court held that the expenses were nondeductible personal expenses because the expenses were not ordinary expenses for a school teacher. 26 The Tax Court explained that expenses are not ordinary unless they are customary or occur frequently within the industry in question. 27 The Tax Court found that Ms. Hill failed to prove that school teachers ordinarily attend summer school to renew their teaching certificates. 28 The Fourth Circuit rejected the Tax Court s characterization of the expenses as personal. 29 The Fourth Circuit held that because the attendance of summer school was an authorized means for renewing a certification, the courses were ordinary and necessary to the taxpayer s business of being a school teacher. 30 The Hill decision brought about sweeping changes in the tax treatment of educational expenses. After the Fourth Circuit s decision in Hill, the IRS modified its prior Office Decision on the deductibility of a teacher s summer-school expenses. 31 The United States Court of Appeals for the Second Circuit, relying on the Hill decision, allowed a tax attorney a deduction for the cost associated with attending a tax conference sponsored by the Federal Tax Institute. 32 The Second Circuit s decision reversed the Tax Court s decision on the matter. 33 The Tax Court had held that such expenses were nondeductible personal expenses. 34 In 1958, shortly after the Hill case, the IRS issued the original Regulation , directly addressing the circumstances when 25. Id. at 906, Hill v. Comm r, 13 T.C. 291, 295 (1949), rev d, 181 F.2d 906 (4th Cir. 1950). 27. Id. at Id. at Hill, 181 F.2d at Id. at I.T. 4044, C.B. 16. The Office Decision held that [s]ummer school expenses incurred by a public school teacher in order to maintain her position are deductible as ordinary and necessary business expenses under section 23(a)(1)(A) of the Internal Revenue Code, and such expenses may be deducted in determining adjusted gross income under section 22(n) of the Code. Id. 32. Coughlin v. Comm r, 203 F.2d 307, 309 (2d Cir. 1953). 33. Id. at Coughlin v. Comm r, 18 T.C. 528 (1952), rev d, 203 F.2d 307 (2d Cir. 1953).

7 2011] EDUCATIONAL EXPENSES 253 educational expenses were deductible under Section Under the 1958 Regulation, a taxpayer was entitled to a deduction for educational expenses under Section 162 if the taxpayer could demonstrate the following: 1. the expenses were not undertaken primarily for personal purposes or for obtaining a new position or substantial advancement in position; 36 and 2. the education was undertaken for the primary purpose of either: a. maintaining or improving the taxpayer s skills in the taxpayer s current trade or business or employment; or b. meeting the express requirements of the taxpayer s employer or the requirements of applicable law or regulation. 37 The determination of a taxpayer s primary purpose in incurring educational expenses under the 1958 Regulation was based on all of the facts and circumstances. 38 This subjective inquiry led to inconsistent results and proved to be unworkable. 39 For example, in King v. Commissioner, a visiting high-school teacher was allowed a deduction for expenses associated with pursuing a Ph.D. 40 However, in Devereaux v. Commissioner, a college professor was denied a deduction for the cost of Ph.D. studies. 41 In Devereaux, the Tax Court held that the college professor s primary purpose in obtaining the Ph.D. was to qualify the taxpayer for a new position. 42 While in King, the Tax Court concluded that the visiting high-school teacher was pursuing the Ph.D. for the primary purpose of improving or 35. See Treas. Reg (1958), amended by T.D. 6918, 32 Fed. Reg (1967) (b) (1958), amended by T.D. 6918, 32 Fed. Reg (1967) (a) (1958), amended by T.D. 6918, 32 Fed. Reg (1967). 38. Id. 39. See Musselman, supra note 8, at 931; Sanchez, supra note 10, at 664; Schoenfeld, supra note 8, at T.C.M. (CCH) 495 (1962) T.C.M. (CCH) 453 (1960), rev d, 292 F.2d 637 (3d Cir. 1961). 42. Id. at 456.

8 254 THOMAS M. COOLEY LAW REVIEW [Vol. 28:2 maintaining her skills. 43 The taxpayer in King was pursuing a Ph.D. in education from Stanford University. 44 The primary-purpose test also led to inconsistent results with other types of educational expenses. The test led to a substantial amount of litigation over the deductibility of law degrees, and the results did not always seem consistent. 45 In Kilgannon v. Commissioner, the Tax Court found that an accountant s primary motivation in obtaining a law degree from the New York University School of Law was the improvement of his skills and allowed a deduction for the related expenses. 46 In contrast, an IRS agent was denied a deduction for expenses associated with a law degree in Engel v. Commissioner. 47 The Tax Court in Engel concluded that the IRS agent was pursuing the degree for the purpose of qualifying himself for a different profession. 48 The court reasoned that it was not relevant that the taxpayer planned to stay employed by the IRS because the taxpayer could pursue a new profession within the IRS. 49 B. The Current Regulation In 1967, the IRS amended Regulation , eliminating the subjective primary-purpose test. 50 The 1967-amended Regulation remains in effect today. Under the current Regulation, educational expenses will only be treated as deductible ordinary-and-necessary business expenses if the following three requirements are satisfied: the education maintains or improves the taxpayer s skills in his employment or other trade or business, 51 meets the express requirements of the individual s 43. King, 21 T.C.M. (CCH) at Id. at Compare Welsh v. United States, 329 F.2d 145 (6th Cir. 1964) (allowing an IRS employee a deduction for expenses associated with pursuing a law degree), with Engel v. Comm r, 21 T.C.M. (CCH) 1302 (1962) (denying an IRS agent a deduction for expenses associated with pursuing a law degree) T.C.M. (CCH) 619 (1965) T.C.M. (CCH) at Id. at Id. 50. T.D. 6918, C.B. 36, Treas. Reg (a) (as amended in 1967).

9 2011] EDUCATIONAL EXPENSES 255 employer, or meets the requirements of applicable law or regulations; 52 the education was not required to meet the minimum educational requirements 53 for qualification in the taxpayer s employment or other trade or business; 54 and the education is not part of a program of study being pursued by the taxpayer that will lead to qualifying the taxpayer in a new trade or business. 55 The first requirement, that the education maintains or improves skills or meets express employer or legal requirements, is identical to the requirement imposed under the 1958 version of Regulation However, under the current Regulation, if the taxpayer demonstrates that the education maintained or improved skills or was undertaken to satisfy the employer or legal requirements, the expenses are not deductible if the education was required to meet minimum educational requirements or would qualify the taxpayer in a new trade or business. 57 Expenses that either satisfy minimum educational requirements or qualify the taxpayer in a new trade or business are treated as nondeductible personal expenses without exception and without regard to the relationship the expenses have to the taxpayer s current trade or business. 58 The minimum-education test has not proved controversial and has generally been applied in a fair and consistent manner. The same 52. Id (b)(2)(ii) ( The minimum educational requirements for qualification of a particular individual in a position in an educational institution is the minimum level of education (in terms of aggregate college hours or degree) which under the applicable laws or regulations, in effect at the time this individual is first employed in such position, is normally required of an individual initially being employed in such position. ) (b)(2)(i). The Regulation provides that the fact that an individual is already working in a specific profession does not establish that the individual has already met the minimum educational requirements for that profession. Id (b)(3)(i). 56. See supra note 37 and accompanying text (b)(1). 58. Id.

10 256 THOMAS M. COOLEY LAW REVIEW [Vol. 28:2 cannot be said for the new-trade-or-business test. 59 As a result, the focus of this Article is on the new-trade-or-business test. C. The New-Trade-or-Business Test Part of the issue with the new-trade-or-business test is that it has not been consistently applied. 60 The Regulation provides four examples of what constitutes and what does not constitute a new trade or business; 61 however, the Regulation does not define the term or provide a test to make this determination. 62 The Regulation actually creates confusion as to whether the new-trade-or-business test is to be applied objectively or based on a taxpayer s particular facts. Regulation (b)(3)(i) provides, In the case of an 59. See supra note 10 and accompanying text. 60. See, e.g., DeBoy, supra note 10, at ; Kalafat, supra note 10, at ; Musselman, supra note 8, at ; Sanchez, supra note 10, at The Regulation has examples that apply solely to teachers under (b)(3)(i) and the following non-teacher examples under (b)(3)(ii): Example 1. 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. Example 2. Assume the same facts as in example (1) except that A has the status of an employee rather than a self-employed individual, and that his employer requires him to obtain a bachelor of laws degree. A intends to continue practicing his nonlegal profession as an employee of such employer. Nevertheless, the expenditures made by A in attending law school are not deductible since this course of study qualifies him for a new trade or business. Example 3. B, a general practitioner of medicine, takes a 2-week course reviewing new developments in several specialized fields of medicine. B s expenses for the course are deductible because the course maintains or improves skills required by him in his trade or business and does not qualify him for a new trade or business. Example 4. C, while engaged in the private practice of psychiatry, undertakes a program of study and training at an accredited psychoanalytic institute which will lead to qualifying him to practice psychoanalysis. C s expenditures for such study and training are deductible because the study and training maintains or improves skills required by him in his trade or business and does not qualify him for a new trade or business (b)(3)(ii). 62. See ; see also Kalafat, supra note 10, at 2010.

11 2011] EDUCATIONAL EXPENSES 257 employee, a change of duties does not constitute a new trade or business if the new duties involve the same general type of work as is involved in the individual s present employment. 63 This language seems to indicate that, at least in the case of employees, the courts should examine the functions performed by the employee before pursuing the additional education at issue and those functions performed after to determine whether the additional education qualified the taxpayer for a new trade or business. 64 Under the samegeneral-type-of-work test, if an employee continued to perform the same general tasks after completing additional education as before, it would seem under this language that the educational expenses should not result in the employee being treated as qualifying for a new trade or business. 65 In some cases, the courts have relied on the samegeneral-type-of-work test to find that education did not qualify a taxpayer in a new trade or business. 66 In Blair v. Commissioner, the Tax Court found that food-marketing courses taken by a supermarket manager, which were needed to advance professionally in retail food sales, did not qualify the taxpayer in a new trade or business. 67 Relying on the same-general-type-of-work test, the court held that the food-marketing program did not qualify as a new trade or business. 68 The court found that any new duties and advancements within food retail would involve the same general type of work that the supermarket manager performed. 69 Commentators have questioned the appropriateness of the samegeneral-type-of-work test. 70 The test is inconsistent with the results reached under the Regulation s examples and does not add anything to the enumerated requirements of Section 162. One commentator (b)(3)(i). 64. See Musselman, supra note 8, at See Blair v. Comm r, 41 T.C.M. (CCH) 289, (1980) (finding educational expenses deductible after applying the same-general-type-of-work test); see also Granger v. Comm r, 39 T.C.M. (CCH) 1158, (1980) (allowing a deduction for the cost of a management degree after applying the samegeneral-type-of-work test). 66. Blair, 41 T.C.M. (CCH) at 291; Beatty v. Comm r, 40 T.C.M. (CCH) 438, 441 (1980); Granger, 39 T.C.M. (CCH) at T.C.M. (CCH) at Id. at Id. 70. See Musselman, supra note 8, at ; Schoenfeld, supra note 8, at

12 258 THOMAS M. COOLEY LAW REVIEW [Vol. 28:2 referred to the same-general-type-of-work test as the polar opposite of the objective approach required by the 1967 Regulations under the new trade or business test. 71 The examples from the Regulation make it abundantly clear that the new-trade-or-business test was intended as an objective standard. 72 In Example 2, an individual taxpayer works as an employee in a profession other than law (for example, accounting) and is asked by his employer to attend law school. 73 After completing the law degree, the employee will return to his nonlegal profession. 74 Despite the fact that the employee will continue to perform the same general type of duties after attending law school, Example 2 provides that the educational expenses are not deductible because the course of study qualifies the taxpayer for a new trade or business. 75 Under Example 2, the fact that a taxpayer s general tasks and functions will not change after completing the education is irrelevant. 76 The example provides that if the education in question qualifies the taxpayer for a new trade or business, then no deduction is allowed. 77 Clearly, Example 2 envisions a purely objective standard. This objective standard is consistent with the history of the current Regulation. The current Regulation was intended to eliminate the subjective primary-purpose test under the 1958 version of the Regulation. 78 The notice of rulemaking for the current Regulation explains that the Regulation was enacted to provide a more specific objective test than that provided in the 1958 version. 79 To confuse the situation further, the Regulation provides a separate set of examples that apply only to teachers. The Regulation specifically states that all teaching and related duties shall be considered to involve the same general type of work. 80 The examples clarify this point by providing that changes in duties from a 71. See Musselman, supra note 8, at See Treas. Reg (b)(3)(ii) (as amended in 1967); see also supra note (b)(3)(ii). 74. Id. 75. Id. 76. Id. 77. Id. 78. See Sanchez, supra note 10, at Notice of Proposed Rule Making, 31 Fed. Reg (Oct. 1, 1966). 80. Treas. Reg (b)(3)(i) (as amended in 1967).

13 2011] EDUCATIONAL EXPENSES 259 classroom teacher to a guidance counselor or principal do not constitute a new trade or business. 81 III. FUNDAMENTAL FLAWS WITH REGULATION A. The Inconsistent Treatment of Educational Expenses 1. Subjective vs. Objective Understandably, the courts have struggled to consistently apply a test to determine whether a taxpayer s educational expenses result in the taxpayer qualifying to work in a new trade or business. Several courts have adopted the common-sense approach in making these determinations. 82 The common-sense approach requires that a comparison be made between the types of activities that the taxpayer was qualified to perform before acquiring a particular title or degree with those that he or she was qualified to perform afterwards. 83 As several courts have recognized, a literal reading of the common-sense approach requires an objective inquiry. 84 However, not all courts have utilized the common-sense approach to examine educational expenses, 85 and some courts that have applied this an approach have (b)(3)(i)(c) (d); see also (b)(3)(i)(a) (b) (providing that teachers are not treated as qualifying for a new trade or business when they change the subject matter that they teach or change from an elementary- to secondaryschool teacher). 82. See, e.g., Wiertzema v. United States, 747 F. Supp (D.N.D. 1989); Stenslet v. Comm r, No S, 2010 WL (T.C. Aug. 30, 2010); Allemeier v. Comm r, 90 T.C.M. (CCH) 197 (2005); Lewis v. Comm r, No S, 2002 WL (T.C. May 7, 2002); Hewett v. Comm r, 71 T.C.M. (CCH) 2350 (1996); Dierker v. Comm r, 68 T.C.M. (CCH) 535 (1994); Goldstein v. Comm r, 52 T.C.M. (CCH) 1481 (1987); Diaz v. Comm r, 70 T.C (1978), aff d, 607 F.2d 995 (2d Cir. 1979) (unpublished table decision); Glenn v. Comm r, 62 T.C. 270 (1974). 83. Allemeier, 90 T.C.M. (CCH) at See, e.g., Hewett, 71 T.C.M. (CCH) at 2352; Davis v. Comm r, 65 T.C. 1014, 1019 (1976); O Donnell v. Comm r, 62 T.C. 781, 783 (1974), aff d, 519 F.2d 1406 (7th Cir. 1975) (unpublished table opinion); Bodley v. Comm r, 56 T.C. 1357, 1360 (1971); see also Sanchez, supra note 10, at See, e.g., Singleton Clarke v. Comm r, No S, 2009 WL (T.C. Dec. 2, 2009); Blair v. Comm r, 41 T.C.M. (CCH) 289 (1980); Granger v. Comm r, 39 T.C.M. (CCH) 1158 (1980); Sherman v. Comm r, 36 T.C.M. (CCH) 1191 (1977).

14 260 THOMAS M. COOLEY LAW REVIEW [Vol. 28:2 ignored the objective nature of the test. 86 As a result, the new-tradeor-business test has not been consistently applied. In some cases, the courts have examined whether the taxpayer s job functions have changed, 87 and in others, the courts have applied an objective standard under which the actual task performed by the taxpayer after completing the additional education is not relevant. 88 Wiertzema v. United States is a good example of when the court examined whether the taxpayer s actual job functions had changed after completing additional education. 89 The taxpayer in Wiertzema, a farmer, completed a sixteen-week welding course offered by a local welding school. 90 The taxpayer did not take the course to be hired as a welder; instead, he planned to use the welding skills on his farm for repairing machinery and equipment and constructing and maintaining various farm implements. 91 The taxpayer had done some welding on the farm prior to taking the welding course. 92 The court specifically stated that after completing the welding course, the taxpayer was qualified to work as a welder anywhere in the United States. 93 The court recognized that the outcome of the case depended on whether the new-trade-or-business test was applied by looking objectively at whether the taxpayer was qualified to work in another trade or business after completing the welding course or by looking at whether the taxpayer had actually changed job functions after completing the coursework. 94 The court chose not to apply the objective test and, instead, examined whether the taxpayer performed significantly different tasks and activities after completing the 86. See, e.g., Allemeier, 90 T.C.M. (CCH) See supra note 65 and accompanying text. 88. See, e.g., Lewis v. Comm r, No S, 2002 WL (T.C. May 7, 2002) (holding that the fact that the taxpayer s duties were not changing after obtaining an MBA was not relevant); Gates v. Comm r, 36 T.C.M. (CCH) 970 (1977) (holding that the taxpayer s individual circumstances are not relevant to whether his educational expenses are deductible); O Donnell, 62 T.C. 781 (holding that the taxpayer s intent was not relevant under the new-trade-or-business test) F. Supp. 1363, (D.N.D. 1989). 90. Id. at Id. 92. Id. 93. Id. 94. Id. at

15 2011] EDUCATIONAL EXPENSES 261 education as compared to those tasks and activities performed prior to completion. 95 The court in Wiertzema stated that it was following the commonsense approach set forth in Diaz v. Commissioner, 96 rather than an objective approach. 97 In Diaz, the Tax Court stated, If the education qualifies the taxpayer to perform significantly different tasks and activities than he or she could perform prior to the education, then the education qualifies him or her for a new trade or business. 98 The Tax Court in Wiertzema interpreted the common-sense approach to require an analysis of the actual task that the taxpayer performed before and after completing the education at issue to determine whether the taxpayer qualified for a new trade or business. 99 The court concluded that the actual task that the taxpayer performed had not changed after completing the course and allowed the deduction. 100 The Wiertzema court s holding seems to reach the correct result under Section The educational expenses appear to be ordinary-and-necessary expenses for the taxpayer s trade or business. Possibly, the court adopted a standard that is consistent with requirements of Section 162. However, the court s holding is not consistent with the new-trade-or-business test as applied in Example 2 of the current Regulation. 102 Clearly, the welding course qualified the taxpayer to work in a new trade or business. As discussed above, the court recognized that after completing the welding course, the taxpayer was qualified to work as a welder anywhere in the United States. 103 Presumably, the taxpayer could not have obtained a position as a welder prior to completing the course. Example 2 of the Regulation makes it clear that the taxpayer planning to continue to work as a farmer after completing the welding course is not relevant 95. Id. 96. Diaz v. Commissioner, 70 T.C (1978), aff d, 607 F.2d 995 (2d Cir. 1979) (unpublished table decision). 97. Wiertzema, 747 F. Supp. at Diaz, 70 T.C. at Wiertzema, 747 F. Supp. at Id Courts have disallowed an educational-expenses deduction even though they have recognized that the expense meets the requirements of Section 162. See Roussel v. Comm r, 38 T.C.M. (CCH) 565, 566 (1979) See Treas. Reg (b)(3)(ii) (as amended in 1967) Wiertzema, 747 F. Supp. at 1364.

16 262 THOMAS M. COOLEY LAW REVIEW [Vol. 28:2 to the examination of whether he qualified for a new trade or business. 104 If the Wiertzema court is correct that the new-trade-or-business test is to be applied by examining the task that the taxpayer performed before and after completing the educational course, then the test does not add any additional requirements to Section 162. The plain language of Section 162 specifically requires, for deductibility, that the expenses be paid or incurred during the taxable year in carrying on any trade or business. 105 Courts have consistently held that any expenses of a taxpayer that relate to a new trade or business, rather than the taxpayer s current trade or business, are not deductible under the plain language of Section For example, in Carter v. Commissioner, the court denied an Air Force officer a deduction for expenses related to seeking postretirement employment. 107 The Tax Court held that the expenses did not relate to the taxpayer s employment as an Air Force officer and, therefore, were not deductible under the language of Section An examination of the taxpayer s functions performed before and after the educational expenses under the new-trade-or-business test would seem to make this test superfluous. 109 In other cases where the courts have applied the common-sense approach, they have done so in an objective fashion. For example, in Glenn v. Commissioner, the court compared activities the taxpayer was qualified to perform both before and after completing the educational program, rather than comparing the activities that the taxpayer actually performed before and after completion. 110 The taxpayer in Glenn worked as a public accountant for over a decade. 111 The taxpayer sat for the Tennessee certified-public-accounting exam on several occasions. 112 In 1970, the taxpayer purchased and attended 104. See (b)(3)(ii) I.R.C. 162(a) (2006) See, e.g., Frank v. Comm r, 20 T.C. 511 (1953) (holding that expenses associated with looking for a new trade or business are not deductible) T.C. 932, 934 (1969) Id See also Musselman, supra note 8, at 957 (arguing that the same general type of work test does harm to the meaning of the new trade or business test ) T.C. 270, (1974) Id. at Id.

17 2011] EDUCATIONAL EXPENSES 263 a month-long CPA-exam review course. 113 The Tax Court denied the taxpayer s deduction for educational expenses. 114 The court found that there was enough of a distinction between the functions performed by a Tennessee public accountant and a Tennessee CPA to hold that the expenses associated with the CPA review course qualified the taxpayer for a new trade or business. 115 The taxpayer in Glenn argued that the expenses should not be treated as qualifying him for a new trade or business because his current job functions would not change as a result of passing the CPA exam. 116 The court rejected this argument, stating: While such assertion may be correct, the touchstone of section (c)(1), Income Tax Regs., is only whether or not the education taken will lead to qualification in a new trade or business. Here, as we have found above, the education was directed to so qualify petitioner, and the fact that had he passed the exam, he may not have performed any of the tasks previously not allowed him as a public accountant is simply irrelevant in determining deductibility. 117 The holdings in both Wiertzema and Glenn turned on the application of the new-trade-or-business test. The results in both cases depended on whether the court applied an objective or subjective test. The objective version of the new-trade-or-business test is completely different from an examination of the actual task performed by the taxpayer before and after completing the education. 118 As the Glenn case highlights, the taxpayer s actual activities are not relevant under the objective test; 119 however, such facts are central to the examination of the actual tasks that the taxpayer performed before and after completing the education under 113. Id. at Id. at Id. at Id Id. at Wiertzema v. Comm r, 747 F. Supp. 1363, 1365 (D.N.D. 1989) (acknowledging that the circuits were split on the proper application of the newtrade-or-business test and that the Tax Court has used both approaches) Glenn, 62 T.C. at

18 264 THOMAS M. COOLEY LAW REVIEW [Vol. 28:2 the same-general-type-of-work test. 120 If the court in Glenn had applied the same-general-type-of-work test or the common-sense approach subjectively, then the taxpayer would likely have been allowed a deduction for the educational expenses. 2. MBA Expenses Nowhere has the inconsistent treatment of educational expenses been more apparent than with the cost of obtaining an MBA. 121 The inconsistency has resulted largely from the conflicting application of the new-trade-or-business test. Like other types of educational expenses, the deductibility of an MBA typically depends on which test the court chooses to adopt. In some cases, the courts have either ignored the objective nature of the new-trade-or-business test or applied the same-general-type-of-work test and allowed a deduction for the costs of an MBA as long as the taxpayer was already engaged in his respective trade or business prior to obtaining the MBA. 122 In other MBA cases, courts have focused on the new-trade-or-business test and the common-sense approach. 123 When the common-sense approach has been applied to MBA expenses, it has not been applied consistently Wiertzema, 747 F. Supp. at See DeBoy, supra note 10 (advocating for, among other changes, a courseby-course examination of educational expenses); Sanchez, supra note 10 (arguing that the bright-line denial of a Section 162 deduction for MBA expenses would promote equal treatment among taxpayers, reduce administrative costs, and eliminate opportunities for abuse of the tax system) See, e.g., Singleton Clarke v. Comm r, No S, 2009 WL (T.C. Dec. 2, 2009); Allemeier v. Comm r, 90 T.C.M. (CCH) 197 (2005); see also Blair v. Comm r, 41 T.C.M. (CCH) 289 (1980) (allowing a deduction for MBArelated expenses under the same-general-type-of-work test); Beatty v. Comm r, 40 T.C.M. (CCH) 438 (1980) (allowing an engineer to deduct the costs associated with an MBA after applying the same-general-type-of-work test) Sherman v. Comm r, 36 T.C.M. (CCH) 1191, 1193 (1977) (allowing a military officer a deduction for educational expenses associated with an MBA from Harvard) Compare Blair, 41 T.C.M. (CCH) at (finding that MBA-related expenses were deductible because the taxpayer duties before and after the education were similar), with Lewis v. Comm r, No S, 2002 WL (T.C. May 7, 2002) (denying a deduction for MBA-related expenses on the grounds that the degree qualified the taxpayer to perform significantly different tasks than he performed prior to obtaining the MBA).

19 2011] EDUCATIONAL EXPENSES 265 In Singleton Clarke v. Commissioner, a 2009 Tax Court summary opinion, the court held that a nurse was entitled to deduct the cost of an MBA with a specialization in healthcare management. 125 The court stated, The decisive factor generally is whether the taxpayer was already established in their trade or business. 126 The taxpayer in Singleton Clarke had worked as a nurse in various positions for over twenty years prior to obtaining the MBA. 127 At the time the taxpayer obtained the MBA, she was working as a quality-improvement coordinator. 128 Her duties included coordinating, planning, and implementing the hospital s performance-improvement activities. 129 The court found that the MBA improved the taxpayer s pre-existing skills for her same general duties and that the taxpayer s trade or business had not significantly changed as a result of the MBA. 130 Having found that the taxpayer had already established herself in her trade or business, the court allowed the Section 162 deduction for the MBA expenses. 131 The Singleton Clarke court seems to treat the two distinct issues whether the taxpayer was engaged in her trade or business prior to obtaining the MBA and whether the MBA qualified the taxpayer for a new trade or business as one single issue. The court stated that the new-trade-or-business test involves an objective inquiry that analyzes the tasks and activities that the taxpayer was qualified to perform before the education in comparison to those activities and tasks that the taxpayer was qualified to perform after the education. 132 The court then stated that it is irrelevant whether the taxpayer actually becomes employed in a new trade or business. 133 However, the court then failed to follow through and analyze whether the taxpayer s MBA qualified her to perform activities that she was not qualified to perform prior to the MBA. 134 Rather than focus on the tasks that the taxpayer was qualified to perform after completing the 125. Singleton Clarke, 2009 WL Id Id Id Id Id Id Id Id See id.

20 266 THOMAS M. COOLEY LAW REVIEW [Vol. 28:2 MBA, the court focused on the tasks that the taxpayer was actually performing after completing the MBA program. 135 Finding that the taxpayer was essentially performing the same tasks before and after completing the MBA, the court concluded that the MBA did not qualify Singleton Clarke for a new trade or business. 136 Similarly, in Allemeier v. Commissioner, the Tax Court found that an MBA from Pepperdine University did not qualify a dentalproducts salesman for a new trade or business. 137 The salesman was allowed to deduct the cost of the MBA. 138 The taxpayer in Allemeier decided to pursue the MBA after he was told by his employer that an MBA would speed his advancement within the company and enhance his business skills. 139 The taxpayer had an excellent reputation with his employer and, shortly after enrolling in the MBA program, was promoted to several new positions. 140 The taxpayer s duties expanded after the promotions. 141 Similar to Singleton Clarke, the court in Allemeier specifically stated that the determination of whether the MBA qualified the taxpayer for a new trade or business involved an objective inquiry. 142 The court went on to provide that the common-sense approach requires that a comparison be made between the types of activities that the taxpayer was qualified to perform before acquiring a particular title or degree with those that he or she was qualified to perform afterwards. 143 The focus of the court s analysis was not, however, on the activities the taxpayer was qualified to perform before and after obtaining the MBA. Instead, the court examined the actual activities that the taxpayer performed before and after completing the MBA program. 144 In contrast, in other MBA cases, the courts have focused solely on whether the education qualifies the taxpayer for a new trade or 135. See id Id T.C.M. (CCH) 197 (2005) Id. at Id. at The taxpayer was promoted to Marketing Manager, Managing Director of the Appliance Therapy Practitioners Association, Head of the SMILE Foundation, Practice Development Consultant, and Project Development Consultant. Id Id Id. at Id Id. at 201.