by Jill L. Bielaczyc-Meredith
as appeared in
the Monday, February 1, 1999 edition of The Wharton Journal, (Volume 43, Number 4)
Included in the Taxpayer Relief Act of 1997 were various provisions benefiting students. Specifically, one component of the Act provided benefits directly to taxpayers incurring expenses attributable to post-secondary and continuing education. Beginning on July 1, 1998, taxpayers became eligible to claim a nonrefundable Lifetime Learning Credit against their federal income taxes. The maximum credit a taxpayer may claim for a taxable year is $1,000 through 2002, and thereafter $2,000. Graduate Students can use this credit. In fact, taxpayers participating in any type of continuing education can utilize the credit as long as the coursework is at an eligible educational institution. Even so, the utilization of the credit may not be as advantageous as the direct expensing of one’s graduate education.
The Internal Revenue Code provides for the deductibility of educational expenses when certain requirements are met. Not only is the basis for this deduction in the Code, but also it is apparent in the Treasury Regulations and Case Law. Additionally, the Internal Revenue Service, (IRS), has substantiated the deductibility of Graduate School expenses in IRS Publication 508, titled “Educational Expenses”. To qualify for a deduction of educational expenses a taxpayer must satisfy a few simple rules. The first is that the taxpayer must have established him or herself in a trade or business prior to matriculating in B-School. Additionally, the education must maintain or improve skills needed in his/her established field. There also needs to be a nexus between the pre-MBA and the post-MBA. If an MBA is returning to his/her prior employment after B-School there is an evident connection. Sometimes, the link may not be via employment but in functional expertise. For example one working in commercial banking prior to B-School, and moving into investment banking afterwards demonstrates the necessary nexus.
If someone’s educational expenses qualify, as discussed above, it may be far more advantageous to deduct the expenses than it would be to utilize the Lifetime Learning Credit, (Credit). The Credit, which will offset a taxpayer’s tax liability, is calculated by multiplying twenty percent times the taxpayer’s qualified educational expenses, maximizing out to a $1,000 credit. Therefore, a taxpayer is really only getting a benefit of $5,000 of their educational expenses. Typically, at most Graduate Schools one semester of expenses are in excess of $15,000. This being the case then a taxpayer needs to maximize their tax savings by utilizing both the Credit and the tax deduction if they qualify, (or just utilize the expensing method).
In a situation where a taxpayer’s facts and circumstances do not lend themselves to the argument that their educational expenses are deductible they should be utilizing the Credit. To claim the Credit on one’s tax return there must be an election made on a timely filed tax return. The election and credit calculation will be made on a Federal Form 8863, which will be attached to the taxpayer’s Federal Form 1040, (Individual Income Tax Return). A timely filed tax return is defined as one that is filed within the Internal Revenue Service prescribed deadlines including extensions.
If a taxpayer’s facts and circumstances lend themselves to the argument that their educational expenses are deductible they need to make sure that they are obtaining the full tax benefit of all of the educational dollars spent. This would mean either a deduction of all qualified educational expenses or just the expenses that exceed the Credit thresh hold. In the case of the latter method one would utilize the first $5,000 of qualified educational expenses in obtaining the Credit and then deduct the excess expenses. There cannot be any double benefit in that any qualified tuition and related expenses that are deducted under Internal Revenue Code Section 162 cannot be used to obtain a Credit.
As with most aspects of one’s personal tax and financial matters it is always good to consult with a qualified professional before attempting to utilize any of these strategies on one’s personal income tax return.
Jill L. Bielaczyc-Meredith is an associate with the firm Business Financial Consultants, Inc., (BFC), located in Dearborn, Michigan. BFC handles tax and financial matters for businesses and individuals located on five continents. Jill works with individual tax clients in most major cities of the United States. Jill has been providing tax consul for over nine years with three of them being with the tax department at Deloitte & Touche, LLP. BFC’s web site is www.bfcinc.com. Jill’s email address is: firstname.lastname@example.org.