Business Deductions for Work-Related Education
The tax code allows a taxpayer to deduct educational expenses for improving or maintaining current job skills, but not if the education qualifies the taxpayer for a new occupation. To be able to deduct work-related educational expenses as business expenses, the taxpayer must satisfy the following requirements:
- the taxpayer must be either working as an employee or be self-employed;
- the educational expenses must be deductible.
To deduct the expenses, an employee must itemize deductions on Schedule A, Itemized Deductions, while the self-employed can use Schedule C, Profit or Loss from Business, Schedule C-EZ, Net Profit for Business, or Schedule F, Profit or Loss from Farming.
For employees, the deduction for work-related educational expenses plus other job and certain miscellaneous expenses must exceed 2% of the employee's adjusted gross income (AGI). The self-employed get a much better deal, since the educational expenses can be deducted directly from business income, thus reducing gross income subject both income taxes and self-employment taxes.
The deduction for work-related business expenses can also be combined with other deductions and educational tax credits. However, no expense can be used for more than one deduction or tax credit.
Does the Education Improve Current Skills or Does It Qualify the Taxpayer for a New Occupation?
Qualifying work-related education must satisfy 1 of the following:
- the education maintains or improves skills needed in the taxpayer's present work,
- the employer requires the education for a bona fide business purpose, or
- the education is required by law for the taxpayer to maintain her job, status, or salary.
The education can qualify even if it leads to a degree, unless the degree qualifies a taxpayer for a new trade or business or is required to meet the minimum educational requirements of the taxpayer's trade or business. The reason why minimum educational requirements for a trade or business do not qualify as work-related education is because without the educational requirements, the taxpayer would not be able to work in the trade or business. Thus, by getting the minimum educational requirements, the taxpayer is, in effect, qualifying for a new trade or business. This is in contrast to the situation where the law requires additional education simply to maintain a job that the taxpayer already has.
However, if the taxpayer receives more education than is required by the employer or by the law, the additional education can still qualify as deductible work-related education if it maintains or improves the skills required in the taxpayer's current job.
A good example of a deductible work-related education is a requirement for most teachers to continue their education even as they are teaching. They have satisfied the minimum requirements to be able to teach, but they must take additional courses in later years to maintain their job.
A subtle distinction to note is that if the education also qualifies the taxpayer for a new trade or business, even if it also maintains or improves skills required for the taxpayer's current work, then it will not qualify as work-related education, even if the taxpayer's intention was simply to improve current job skills and never had any intention of entering a new trade or profession.
Generally, educational requirements are determined by laws and regulations, professional or business standards, or by the employer. Once the minimum educational requirements have been met by the taxpayer, then, if the requirements are increased, and the taxpayer must take additional courses to meet the new requirements, it is not considered a new trade or profession. On the other hand, there is no presumption that the minimum educational requirements have been met by the taxpayer simply because she currently works in the trade or business. So a college student who works for a company in the profession that she is pursuing, cannot claim a work-related educational expense if the profession requires a college degree.
The new trade or business rule applies even if the taxpayer has no plans of entering the business. On the other hand, an employee whose duties have changed, and who needs additional education or a refresher course or to study new developments in the field, is not considered getting an education for a new trade or profession, and therefore qualifies for the work-related education. Education that leads the taxpayer to be able to practice another aspect of the profession is considered work-related education rather than a new trade or business. So if a psychiatrist studies at an accredited psychoanalytic institute so that he can qualify to perform psychoanalysis, then it is considered work-related education, and thus, deductible.
However, review courses to prepare for examinations that are frequently required for professionals, such as the bar examination or the exam for certified public accountant, are not considered qualifying work-related education, since they are necessary to qualify for the new profession.
If the taxpayer takes a leave of absence from work to attend an educational institution on a temporary basis, then the absence is considered a temporary absence. Otherwise, the absence is considered indefinite, in which case, the tax law presumes that the education will qualify the taxpayer for a new trade or business, even if it also improves and maintains the skills of the taxpayer's job before the absence. That the taxpayer works for a different employer after the temporary absence will not disqualify the deductibility of the educational expenses, if the educational expenses would otherwise be qualified.
Temporary basis is defined as the expected attendance at school to be one year or less and that it actually does not exceed that time. However, if school attendance is realistically expected to last more than one year, then it is not considered a temporary basis, even if actual attendance turns out to be one year or less. If school attendance was realistically expected to not exceed one year, but later on, new information increases the expected time span to be more than one year, then the temporary basis is considered only temporary up until the time when realistic expectations changed, in which case, expenses that were incurred before the realistic expectations changed will still be deductible, but expenses incurred afterward will not be.
A regularly employed taxpayer who attends school on a temporary basis can deduct the round-trip cost of transportation between home and school or between work and school, regardless of the school's location, the distance traveled, or whether the school was attended on non-work days.
Requirements for Teachers
States or school districts generally set the minimum educational requirements for teachers that include a college degree and a minimum number of college hours thereafter for continuing education. If there are no requirements, then the minimum educational requirements are considered to have been met if the taxpayer becomes a faulty member, which will be assumed if the taxpayer has tenure, worked for several years of service that count toward obtaining tenure, can vote in faculty decisions, and the school makes contributions to the taxpayer's retirement plan other than Social Security or other such plan.
Example: a taxpayer with a bachelor's degree is working as a temporary instructor at a university, while also taking graduate courses for an advanced degree, so that he can become a faculty member of the university. According to university rules, the taxpayer must continue working as an instructor while also working for the degree in order to qualify as a new faculty member. In this case, the graduate courses do not qualify for work-related education, since they lead to a new position that requires a minimum educational requirement.
The tax law assumes that when a teacher gets certified in one state, then the teacher is certified in all states. If a teacher must take additional courses to receive certification in another state, then those courses will be considered work-related educational expenses, since the teacher has already met the minimum requirements for being a teacher in at least one state. So teaching in another state is not considered a new trade or business, since the teacher is practicing the same profession.
Teaching and related duties are considered the same kind of work, such as when an elementary school teacher starts to teach secondary school, or a teacher of one subject starts teaching another subject or when a teacher becomes a guidance counselor or a school administrator. These are all considered related to teaching and thus any additional education required to perform any new duties will be considered qualified work-related education.
Generally, personal expenses are not deductible. Moreover, if the taxpayer was entitled to receive reimbursement from an employer for educational expenses but did not claim the reimbursement, then the taxpayer cannot deduct it.
Deductible expenses include tuition, books, supplies, lab fees, research and typing costs, and certain transportation and travel costs. However, no expenses can be deducted if they were paid with tax-exempt or excluded income or if they were used for calculating other educational tax credits or deductions , since the tax law never allows the application of credits and deductions for the same expenses nor can they be applied to expenses paid with tax-exempt income.
Deductible Travel Expenses
Local transportation costs of going directly from work to school are generally deductible and if the taxpayer is regularly employed, but goes to school temporarily, then the cost of returning from school to home is also deductible.
Deductible transportation expenses include the cost of using a car, bus, or subway, or taxi fares. If school attendance is expected to last more than 1 year, then transportation expenses are generally not deductible unless they are from work directly to school. If the taxpayer goes from work to home to school, then only transportation expenses that would be incurred had the worker traveled directly from work to school would be deductible.
Motor vehicle expenses can be deducted by using actual expenses or the standard mileage rate. Additionally, parking fees and tolls are also deductible regardless of the method used to calculate travel expenses.
Travel and lodging are also deductible for any overnight trips to obtain qualifying work-related education. Meals are also deductible, but are subject to the 50%-cost limitation that applies to all meal expenses deducted as business expenses.
Travel expenses for qualifying work-related education are no different from travel expenses incurred by employees for other business purposes. So, for instance, expenses for personal activities such as, visiting, entertaining, or sightseeing are not deductible. Whether a trip is mainly personal or educational depends on the particular facts and circumstances. However, an important consideration is the time spent in doing both. If the taxpayer spends more time on personal travel, then travel expenses will only be deductible if there is an educational reason for traveling to a particular location. However, expenses for any personal trips in the locality of the business-related destination are nondeductible.
If the trip is mainly personal, then the travel cost to and from the destination are nondeductible and only the percentage of meals and lodging equal to the percentage of the work-related education over the entire visit is deductible. So if a taxpayer travels from Philadelphia to Boston for work-related educational courses but spends 3/5 of the time sightseeing, then only 2/5 of lodging and meals are deductible and none of the expenses traveling to and from Boston are deductible.
Expenses for taking work-related courses on cruises or at conventions are limited and subject to additional tax rules.
The tax code does not consider travel to be a form of education, even if it actually is, so it cannot be deducted even if it improves the skills in a current occupation. So if a Spanish teacher goes to Spain on a sabbatical to learn the Spanish language more thoroughly, the costs are still not deductible, even though they are work-related.
Tax Treatment of Reimbursements
If an employee receives reimbursements from the employer, then the tax treatment depends on whether the reimbursements are made from an accountable plan or a nonaccountable plan. An accountable plan is one where expenses must have a business connection, where the employee must adequately account to the employer for the expenses within a reasonable time; and any excess reimbursement or allowance must be paid back to the employer within a reasonable time. Reimbursements under an accountable plan are not included as income to the employee, so reimbursed expenses under an accountable plan are not deductible.
Reimbursements or other expense allowance paid under a nonaccountable plan is generally included as income to the employee. In such a case, the employee can deduct the expenses regardless of whether they were more or less than the reimbursement, since any reimbursement will be included in the employee's income. Any reimbursements for non-deductible expenses are treated as if they were paid under a nonaccountable plan, and, therefore, are includable in the employee's income. The employee must claim the expenses on Form 2106 or 2106-EZ.
Deducting Business Expenses
An employee can only deduct the cost of qualifying work-related education if the employee:
- did not receive any reimbursement from the employer;
- was reimbursed under a nonaccountable plan;
- received reimbursement under an accountable plan but the amount was less than the expenses.
For the self-employed, the expenses incurred because of work-related education, including expenses for a motor vehicle, travel, and meals, are deducted just as regular business expenses, by using the appropriate form: Schedule C, Schedule C-EZ, or Schedule F.
Special rules apply for the expenses of certain performing artists and fee-basis officials and for impairment-related work expenses.
Allowing Full Deductions for All Educational Expenses Could Increase Allocative Efficiency
Why not make all education fully tax-deductible, even if it leads to a new career? Why? Because the economy would work more efficiently. Aren't employers always complaining that there are not enough qualified people for their jobs? Much unemployment — specifically, structural unemployment — results from the fact that employers require specific skills, but there is not enough people with those skills to fill those positions, so the economy suffers as a result.
If they could afford it, more people would take additional education to go on to better paying jobs, and those better paying jobs pay more because the economy has the demand for them. As economists like to say, allocative efficiency is increased when labor has the skills demanded by employers. Therefore, it would benefit the economy to make educational expenses fully tax-deductible, against both earned income and employment taxes, and even allow the carry over of any losses to future years.
Over time, the initial loss in tax revenue will be regained from the higher wages of the better educated, and from the more efficient functioning of the economy, due to a smaller output gap. Moreover, recent graduates tend to spend more, which further stimulates the economy. After all, it makes no sense to allow the deduction of educational expenses when it furthers one's career, but not when it starts a new one.
An employee must file Form 2106, Employee Business Expenses or Form 2106-EZ to deduct employee business expenses, but only if the employee is claiming travel, transportation, meal, or entertainment expenses. Form 2106-EZ, Unreimbursed Employee Business Expenses can only be used if all costs were reimbursed by the employer and included on the employee's Form W-2, and if the employee is only using the standard mileage rate to claim vehicle expenses.
Performing artists or government officials who were paid in whole or in part on a fee basis can deduct the cost of qualifying work-related education as an adjustment to gross income rather than as an itemized deduction. Employee business expenses are listed as a deduction for gross income in the Income section of Form 1040, so it is not subject to the 2% of AGI limit. However, the taxpayer must also attach Form 2106 or 2106-EZ to the return.
Taxpayers who are disabled and have impairment related work expenses that are incurred because of qualifying work-related education can be deducted on Schedule A, Itemized Deductions, in the Other Miscellaneous Deductions section, which is not subject to the 2% AGI limit. Form 2106(-EZ) must be filed, however.
Proof of any deduction must be kept for at least 3 years from the filing date of the tax return in which the deduction is claimed. However, if an employee is reimbursed for all expenses, then the employee does not have to retain records or documentation unless:
- the deduction for expenses is greater than the reimbursement;
- the employer fails to use adequate accounting procedures;
- the expenses were reimbursed under a nonaccountable plan; or
- the taxpayer is related to the employer.
The types are records that must be kept include:
- documents, such as catalogs, course descriptions, transcripts, that show periods of enrollment, the principal subjects studied, and other descriptions of educational activity;
- canceled checks and receipts for educational expenses that are being deducted;
- any amounts of any scholarship or fellowship grants received during the tax year;
- statements from the employer:
- explaining why the education was necessary for the taxpayer's job, salary, or status;
- how job skills were maintained or improved with the education;
- the amount of reimbursement paid to the taxpayer.
- Teachers must also keep the type of certificate and the subjects taught.
|Reimbursement from a Nonaccountable Plan||$2,400||Included in Wages on Form W-2|
|Total Travel Expenses||$1,840|
|Tuition and Books||$600|
|Meal Deduction||$250||= Cost of Meals × 50%|
|Total Deductible Expenses||$2,690||= Total Travel Expenses + Tuition and Books + Meal Deduction|
|2% of AGI||$600|
|Itemized Deduction||$2,090||= Total Deductible Expenses – 2% of AGI|
|Deduction if Standard Deduction is Claimed||0|