The issue of when education expenses represent deductible business expenses involves an analysis of the specific facts for each taxpayer. Reg. §1.162-5 outlines the rules that apply in such cases.

Reg. §1.162-5(a) allows a deduction for ordinary and necessary business education expenses, even if the education may lead to a degree, if the education

Maintains or improves skills required by the individual in his employment or other trade or business, or
Meets the express requirements of the individual’s employer, or the requirements of applicable law or regulations, imposed as a condition to the retention by the individual of an established employment relationship, status, or rate of compensation.[1]

However, such expenses will not be allowed as a deduction, even though they otherwise meet one of the two prior conditions, if:

The education meets the minimum education requirements for qualification in the trade or business,[2] or
The education program being pursued will qualify a taxpayer for a new trade or business.[3]

The minimum education requirements rule is often fairly easy to identify—for instance, a CPA specializing in tax obtaining a degree from a law school will generally not be considered to have incurred a deductible expense, even if the student does not plan to sit for the Bar exam and plans to continue working in the CPA firm.[4]

But the qualification for a new trade or business clause tends to lead to more issues, especially in cases where training would lead to a Masters in Business Administration (MBA) degree. That was the key issue decided in the bench opinion in the case of Zuo v. Commissioner.[5]

Mr. Zuo’s employment and business history before beginning his MBA program was detailed as follows in the opinion:

After receiving his bachelor’s degree, petitioner worked as an investment banking analyst at Goldman Sachs in San Francisco, California for two years. In September 2013, he left Goldman Sachs and began employment as an investment analyst at Solstein Capital, LLC (hereinafter Solstein Capital), a hedge fund located in San Francisco. While working full-time at Solstein Capital, petitioner simultaneously pursued two entrepreneurial technology ventures. In 2014, petitioner founded Wikispective, Inc. (hereinafter Wikispective), which petitioner describes as a project similar to Wikipedia. In 2015, petitioner co-founded 36Names LLC (hereinafter 36Names), a domain name leasing company. Petitioner filed articles of organization for 36Names with the Secretary of State of California on June 12, 2015. He actively worked to grow 36Names throughout 2016. The business registration for 36Names with the State of California was canceled on September 11, 2017. Petitioner’s records indicate that he invested $21,905 of his own funds for startup costs for Wikispective and 36Names.[6]

The taxpayer’s education program for 2016 was described as follows:

In May of 2016, petitioner left his position at Solstein Capital to pursue a MBA degree from the Massachusetts Institute of Technology (hereinafter MIT). He continued to work on 36Names while traveling over the summer of 2016 and after enrolling at MIT in the fall of 2016. While studying at MIT, petitioner and some of his fellow MBA students organized a company called DeepBench LLC (hereinafter DeepBench). Petitioner served as the CEO of DeepBench starting in October of 2016. DeepBench is a company organized under the laws of the State of Delaware that helps connect its clients to expert advisors through its software platform. Petitioner left his position at DeepBench in October 2020 to found and serve as the managing partner for a company called Optionality Partners (a consultancy that advises entrepreneurs on starting businesses from scratch).[7]

Mr. Zuo claimed a $24,412 deduction for the expenses related to his MBA program on his 2016 income tax return. The IRS, after examining the taxpayer’s return, disallowed the deduction in its entirety.

The IRS argued that the skills provided by the program were not required to be successful in his employment with Solstein Capital, apparently viewing the training as being aimed at allowing the taxpayer to pursue a new trade or business as an entrepreneur.

But the Tax Court determined that Mr. Zuo had been in the business of being an entrepreneur and already possessed the necessary qualifications before he began his MBA program. The opinion provided that:

We are satisfied that petitioner was qualified in the trade or business of being an entrepreneur before enrolling in the MBA program at MIT on the basis of the time and money he had previously spent founding, organizing, and assuming the financial risks of his two entrepreneurial ventures, Wikispective and 36Names. Further, petitioner had likely developed significant business acumen that was useful in pursuing these ventures while obtaining an undergraduate degree in business administration and working as an investment analyst at Goldman Sachs and Solstein Capital. Petitioner continued to develop his entrepreneurial skillset when he helped found and served as the CEO of DeepBench starting in 2016.

Although petitioner’s business courses at the MIT MBA program may have honed his leadership, communication, organization, and other skills necessary to run a successful business, they did not “qualify” him for a new trade or business as an entrepreneur. Rather, they maintained and refined skills he was already using in his current business. See Allemeier v. Commissioner, slip op. at 13-14; Sherman v. Commissioner, 36 T.C.M. (CCH) at 1193-1194; sec. 1.162-5(b)(3), Income Tax Regs.[8]

The fact that a taxpayer is not currently working is not fatal to the deduction, so long as he was in the trade or business prior to the program:

A taxpayer may be engaged in a trade or business, although not working, if he was previously involved in and actively sought to continue in that trade or business while pursuing a defined degree program related to his or her line of work. Ford v. Commissioner, 56 T.C. 1300, 1304 (1971), aff’d, 487 F.2d 1025 (9th Cir. 1973); Hitt v. Commissioner, T.C. Memo. 1978-66, 37 T.C.M. (CCH) 333, 334-335 (1978). The taxpayer must clearly intend to seek employment in the same trade or business. Goldenberg v. Commissioner, T.C. Memo. 1993-150, 1993 WL 101367, at *4; see Corbett v. Commissioner, 55 T.C. 884, 887-888 (1971).[9]

The taxpayer’s situation therefore allowed for this deduction:

Beginning in May of 2016 petitioner was not working for an employer in the fields of finance or business. He testified, however, that he continued to work on 36Names throughout the summer and fall of 2016. Although he also testified that he was traveling during the summer of 2016, petitioner clearly intended to continue his professional career as an entrepreneur. See Corbett v. Commissioner, 55 T.C. at 887-888; Goldenberg v. Commissioner, 1993 WL 101367, at *4. We are satisfied that the period from May 2016, when petitioner left his position at Solstein Capital, through October 2016, when petitioner founded DeepBench, was a transition period during which he actively sought to continue in the trade or business of entrepreneurship while pursuing a defined graduate degree program. We conclude that petitioner may be considered to have been carrying on his trade or business during this time. See Ford v. Commissioner, 56 T.C. at 1304; Hitt v. Commissioner, 37 T.C.M. (CCH) at 334-335.[10]

[1] Reg. §1.162-5(a)(1) and (2)

[2] Reg. §1.162-5(b)(2)

[3] Reg. §1.162-5(b)(3)

[4] Reg. §1.162-5(b)(3)(ii) Example 1

[5] Zuo v. Commissioner, Tax Court Bench Opinion, Docket No. 5716-195, July 26, 2021, https://www.taxnotes.com/research/federal/court-documents/court-opinions-and-orders/tax-court-rules-against-irs-in-deductibility-of-mba-tuition/76xyk (retrieved July 26, 2021)

[6] Zuo v. Commissioner, Tax Court Bench Opinion, Docket No. 5716-195, July 26, 2021

[7] Zuo v. Commissioner, Tax Court Bench Opinion, Docket No. 5716-195, July 26, 2021

[8] Zuo v. Commissioner, Tax Court Bench Opinion, Docket No. 5716-195, July 26, 2021

[9] Zuo v. Commissioner, Tax Court Bench Opinion, Docket No. 5716-195, July 26, 2021

[10] Zuo v. Commissioner, Tax Court Bench Opinion, Docket No. 5716-195, July 26, 2021