Accountant-turned-attorney couldn’t deduct law school costs

Here we go again…Watch out when a person qualifies for a new trade or business under the education expense deduction rules!

Santos, TC Memo 2016-100TC Memo 2016-100

The Tax Court has concluded that an accountant could not deduct his law school tuition and fees as ordinary business expenses, finding that such qualified him for a new trade or business and thus were nondeductible under Reg. § 1.162-5(b). The Court also declined to consider the taxpayer’s late-raised arguments challenging the validity of that reg.

Background. Education expenses are deductible under Code Sec. 162(a) if made by a taxpayer either to maintain or improve skills required in his business or employment or to meet the express requirements of his employer, or the requirements of law or regs, if they are imposed as a condition to retaining his salary, status or employment. (Reg. § 1.162-5) The expense is deductible only if the taxpayer is established in the trade or business at the time he pays or incurs the expense. (Jungreis, (1970) 55 TC 58155 TC 581)

Deductions are not allowed if the education:

  • Is needed to meet the minimum requirements for taxpayer’s present or intended employment, trade, business, or profession (Reg. § 1.162-5(b)(2)); or
  • Is undertaken to fulfill general education aspirations or for other personal reasons; or
  • Is part of a program of study that will lead to qualifying the individual in a new trade or business. (Reg. § 1.162-5(b)(3)(i))

Two of the examples in Reg. § 1.162-5(b)(3) illustrating types of nondeductible educational expenses involve individuals who go to law school. In the first example, a self-employed non-lawyer’s law school expenditures are nondeductible because they qualify him for a new trade or business. The second example involves an employee in a nonlegal profession whose employer requires him to get a law degree, and in this example, although the employee intends to continue practicing his nonlegal profession, the expenditures are still nondeductible because the education nonetheless qualifies him to do something new. A number of courts have also held that a law degree qualifies a law student for a new trade or business (i.e., the business of being an attorney) and that, therefore, the cost of a law degree is a nondeductible educational expense under Reg. § 1.162-5(b)(3). (See, e.g., Melnik v. U.S., (CA 9 1975) 36 AFTR 2d 75-566736 AFTR 2d 75-5667)

Facts. Emmanuel Santos began working as a return preparer in ’90. He became an “enrolled agent” authorized to represent taxes before IRS in ’95 and earned a master’s degree in taxation in ’96. He began offering other services to his clients, including financial planning.

At some point, Santos enrolled in law school. He was attending law school in 2010 and, during that year, paid tuition, and fees of $20,275. He later started a law firm with his father that also provides tax and financial planning services.

Santos attached a Schedule C (Profit or Loss from Business) to his 2010 Form 1040 for the “business or profession” of tax and financial planning. On his Schedule C, Santos deducted a variety of expenses, including $20,275 for law school tuition and fees. After concessions from both parties, the remaining issue was whether Santos could deduct the law school tuition and fees.

No deduction. The Tax Court easily concluded, looking at the applicable regs and caselaw, that the law school tuition and fees paid by Santos were not deductible.

Santos also challenged the validity of Reg. § 1.162-5. The Court noted that the reg was challenged shortly after its promulgation and was upheld both by the Tax Court (Weiszmann, (1969) 52 TC 110652 TC 1106) and by the Ninth Circuit Court of Appeals (the relevant Court to which an appeal of this case would lie), which affirmed the Tax Court. (Weiszmann v. Comm., (CA 9 1971) 27 AFTR 2d 71-97027 AFTR 2d 71-970) Specifically, the Tax Court found in Weiszmann that the challenged reg was consistent with statutory law and not arbitrary.

In this case, the Tax Court found that Weiszmann was binding precedent and thus declined to reconsider the validity of the reg. The Court noted that, while the tests for evaluating a reg’s validity are different now than they were when Weiszmann was decided, and while “precedent may lose its force when the underlying law upon which the precedent was based has changed,” it didn’t see any such change warranting a departure from Weiszmann.

The Court also rejected the argument that it should hold the reg invalid under other tests. Santos cited Altera, (2015) 145 TC No. 3145 TC No. 3, in which the Tax Court struck down certain cost-sharing regs for, among other reasons, failure to address “numerous relevant and significant comments.” However, the Tax Court distinguished the regs at issue in Altera as requiring empirical analysis, whereas the education expense regs in the instant case are purely a matter of statutory interpretation. And further, the Court found that Santos failed to challenge the validity of the reg until after trial—so the trial record and court papers have no information regarding public comment on the education expense reg, leaving the Court unable to determine the adequacy of Treasury’s response.

References: For when a person qualifies for a new trade or business under the education expense deduction rules, see FTC 2d/FIN ¶ L-3715; United States Tax Reporter ¶ 1624.185; Tax Desk ¶ 302,013; TG ¶ 16197.

IRS ADDS FAQS ABOUT “GET MY PAYMENT” ECONOMIC IMPACT PAYMENT STATUS

IRS website – Get My Payment Frequently Asked Questions (updated May 20, 2020)

On its website, IRS has added to its FAQs regarding its “Get My Payment” website, which provides information about economic impact payments (EIPs) made under the Coronavirus Aid, Relief, and Economic Security (CARES) Act.

Background. As part of the CARES Act (PL 116-136, 3/27/2020), IRS is making EIPs to certain taxpayers.
Tax filers with adjusted gross income up to $75,000 for individuals and up to $150,000 for married couples filing joint returns receive the full payment. For filers with income above those amounts, the payment amount is reduced by $5 for each $100 above the $75,000/$150,000 thresholds.

Eligible taxpayers who filed tax returns for either 2019 or 2018 automatically receive an EIP of up to $1,200 for individuals or $2,400 for married couples. Parents also receive $500 for each qualifying child under the age of 17 as of the end of 2020.

IRS has set up the Get My Payment website/tool that:
a. Shows taxpayers either their EIP amount and the scheduled delivery date of the EIP by direct deposit or paper check, or that a payment has not been scheduled; and
b. Allows taxpayers who did not use direct deposit on their last filed tax return to provide their direct deposit information which will speed their receipt of their EIP. (Get My Payment tool)

The IRS also has an online “non-filer tool,” that taxpayers who do not file tax returns can use to register to receive their EIPs. See IRS launches new on-line tool to help non-filer register for Economic Impact Payments (4/13/2020) .

The IRS previously updated its FAQs about the Get My Payment website on May 4. See IRS adds FAQs about “Get My Payment” economic impact payment website/tool (05/06/2020) .

Added FAQ. The IRS added FAQs, including:
Q. I am not required to file a tax return. Can I still use Get My Payment to check my payment status?
A. Depending on your specific circumstances, it may not be possible for you to access Get My Payment.
If you used the non-filer tool, then Get My Payment will display your Payment Status and details within two weeks. Until your payment is scheduled, you will receive a “Payment Status Not Available” message.

If you receive Supplementary Security Income (SSI), Survivor or Disability benefits (SSDI), Railroad Retirement benefits or Department of Veterans Affairs beneficiaries and did not file a return or use the non-filer tool, then:
• Get My Payment will display your Payment Status and details once it has been scheduled for delivery. Until then, you will receive a “Payment Status Not Available” message.

• You will not be able to use Get My Payment to provide your bank account information. The IRS will use the information from SSA or VA to generate your payment.

• You will receive your payment as a direct deposit or by mail, just as you would normally receive your benefits. For example, if your benefits are currently deposited to a Direct Express card (a debit card used to receive federal benefits), your EIP will also be deposited to that card. If your benefits are currently deposited to your bank account, your EIP will also be deposited to that account.

If a Direct Express account holder used the non-filer tool to add a spouse or qualifying child, the account holder cannot receive the EIP payment on the Direct Express card. The account holder must select a bank account for direct deposit or leave bank information blank and receive the EIP by mail.

If you did not file a return, did not use the non-filer tool, or are not a recipient of SSA, SSI, RRB or VA benefits, then the IRS may not have enough information on file for you to send you an EIP. In that case, Get My Payment will display a “Payment Status Not Available” message.

Q. I filed jointly with my spouse. Does it matter whose information I use for Get My Payment?
A. Either spouse can use Get My Payment by providing their own information for the security questions used to verify their identity. Once verified, the same payment status will be shown for both spouses. If you receive “Need More Information” and proceed to enter your direct deposit information, you should enter the Adjusted Gross Income (AGI) and Refund Amount or Amount You Owed exactly as it appears on your joint tax return.

The AGI can be found on Line 8b on your 2019 Form 1040 or 1040-SR, or Line 7 on your 2018 Form 1040.
The refund amount can be found on Line 21a on your 2019 Form 1040 or 1040-SR, or line 20a on your 2018 Form 1040.
The amount you owed can be found on Line 23 on your 2019 Form 1040 or 1040-SR, or Line 22 on your 2018 Form 1040.
Your EIP can only be directed to one bank account if you filed jointly.

Q. I requested a direct deposit of my payment. Why are you mailing it to me?
A.There are several reasons why your payment may have been sent by mail, including:
• If the payment was already in process before the bank information was entered, or
• If the bank rejects the deposit because the bank information is invalid or the bank account has been closed.
The IRS will mail your payment to the address IRS has on file for you. Get My Payment will be updated to reflect the date your payment will be mailed. Typically, it will take up to 14 days to receive the payment, standard mailing time.

The IRS notes that it is not possible to change your bank information online once your payment has been processed. Don’t contact the IRS as phone assistors won’t be able to change your bank information either.

Q. My bank account information has changed since I filed. Can I update it using the Get My Payment tool?
A. No. To help protect against potential fraud, the tool does not allow people to change direct deposit information already on file with the IRS.
If the IRS issues a direct deposit and the bank information is invalid or the bank account has been closed, the bank will reject the deposit. The IRS will then mail your EIP as soon as possible to the address it has on file for you, and will update Get My Payment to reflect the date your payment will be mailed.

Q. The Get My Payment website indicates my EIP went to my bank, but I’ve learned it was sent to them in error and has been returned to the IRS for reprocessing. How can I see the status of this payment and where it will be sent?
A. Once reprocessed, these payments will be automatically mailed to the most current address on file. This could be the address identified on a 2019 or 2018 tax return, or the address on file with the U.S Postal Service. Get My Payment tool will update accordingly. However, until the IRS processes the returned payment, there may be a short period where Get My Payment may still indicate the original payment date and direct deposit status.

In mid-April, some taxpayers may have seen an erroneous message when checking Get My Payment, which indicated the EIP was being deposited to the same taxpayer account a second time.

The IRS corrected this reporting error as of Tuesday, April 21 to reflect that the taxpayer’s payment was actually mailed and not rerouted.

Coronavirus Aid, Relief, and Economic Security (CARES) Act tax provisions.

Right now, your highest priority continues to be the health of those you love and yourself.

You may have read an article that I recently published that summarized the Coronavirus Aid, Relief, and Economic Security (CARES) Act tax provisions.

That article included a brief discussion of the CARES Act’s deferral of and changes to the limit on excess business losses.

Here is more about the deferral and changes.

Deferral of the excess business loss limits.

The Tax Cuts and Jobs Act (the 2017 Tax Law) provided that net tax losses from active businesses in excess of an inflation-adjusted $500,000 for joint filers, or an inflation-adjusted $250,000 for other covered taxpayers, are to be treated as net operating loss carryforwards in the following tax year.
The covered taxpayers are individuals (or estates or trusts) that own businesses directly or as partners in a partnership or shareholders in an S corporation.

The $500,000 and $250,000 limits, which are adjusted for inflation for tax years beginning after calendar year 2018, were scheduled under the 2017 Tax Law to apply to tax years beginning in calendar years 2018 through 2025.

But the CARES Act retroactively postponed the limits so that they now apply to tax years beginning in calendar years 2021 through 2025.

The postponement means that you can amend your prior years returns.

Here is what to look for on your individual tax returns.
1. Any filed 2018 returns that reflected a disallowed excess business loss (to allow the loss in 2018) and
2. Any filed 2019 returns that reflect a disallowed 2019 loss and/or a carryover of a disallowed 2018 loss (to allow the 2019 loss and/or eliminate the carryover).

If you filed any such return(s), you need to consider filing an amended tax return as soon as possible.
Note also that the excess business loss limits don’t apply to tax years that begin in 2020.

Thus, such a 2020 year can be a window to start a business with large up-front-deductible items (for example capital items that can be 100% deducted under bonus depreciation or other provisions) and be able to offset the resulting net losses from the business against investment income or income from employment (see below).

Changes to the excess business loss limits.

The CARES Act made several retroactive corrections to the excess business loss rules as they were originally stated in the 2017 Tax Law.

Most importantly, the CARES Act clarified that deductions, gross income or gain attributable to performing services as an employee are not considered in calculating an excess business loss.

This means that excess business losses cannot shelter either net taxable investment income or net taxable employment income.
Be aware of that if you are planning a start-up that will begin to generate, or will still be generating, excess business losses in 2021.

Another change provides that an excess business loss is considered in determining any net operating loss (NOL) carryover but is not automatically carried forward to the next year.

And a generally beneficial change states that excess business losses do not include any deduction under Code Sec. 172 (NOL deduction) or Code Sec. 199A (the qualified business income deduction that effectively reduces income taxes on many businesses).

And because capital losses of non-corporations cannot offset ordinary income under the NOL rules,
1. Capital loss deductions are not considered in computing the excess business loss, and
2. The amount of capital gain considered in computing the loss cannot exceed the lesser of capital gain net income from a trade or business or capital gain net income.

I will be pleased to answer any questions you might have about the above information or any other matters, related to COVID-19 or not.

I continue to wish all of you the absolute best in a difficult time.

Stay safe…!