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.

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About William Murphy

William F. Murphy is the owner of Murphy Financial Group, P.C. The firm emphasizes in providing tax consulting and financial planning services to corporations, professional practices and individuals. He also provides consultation services on tax and financial planning issues to various news and publishing organizations on current tax law changes occurring within federal and state government. He is also the author of the “Murphy Minute” that is syndicated through various news organizations. Mr. Murphy is also associated with the law firm of Mallor Grodner LLP. The firm has offices in both Indianapolis and Bloomington Indiana. He assists in providing tax, valuation and financial analysis services focusing in the areas of Family law and business tax planning. https://www.linkedin.com/in/william-f-murphy-cpa-pfs-abv-cff-cgma-b38aa713/.