Business Education: Costs You Can Deduct

business deductions employee benefits Aug 17, 2021

Small business owners are responsible for maintaining their own skills and qualifications and can also cover educational costs for their employees. Thankfully, education costs even for the business owner can be deducted on taxes, as long as a few criteria are met. Educational expenses can also provide an employee benefit that is not taxable to the employee but deducted for the business. 

Educational costs

Generally the cost to train an employee to do their work is a deductible expense. However, the IRS is concerned with business owners classifying a personal educational expense as a business deduction, which is not permitted. So additional rules exist to determine if an owner can deduct their own education as a business expense. 

The deductibility of work related education expenses is covered by IRS Topic No. 513There are two steps and several other considerations to evaluate before you know if your educational expenses can be deducted. Although the IRS has an electronic interview tool to help make this determination, many education expenses can fall into a grey area.

The steps, tax court cases and factors below will help you make a determination and once you do, it's wise to also discuss with your tax professional. The decision to take the deduction need not be solely up to your tax professional because if you are audited you are the one responsible for the additional tax. So ensure you are also comfortable taking the deduction. 

Step 1

One of the following must be true for the educational cost incurred:

  • The education or training maintains or improves skills needed in your present work, OR
  • There is a legal requirement to obtain the education to keep your present salary or pay, status, position or license. 

The key to this step is that the cost must relate to your present work or position. There has to be a connection to the work you are doing in your business now. An example of a legal requirement is continuing education required to maintain a professional license, without which the license cannot be renewed. 

Step 2

Even if you make it past step one, neither of the following can be true as it relates to the educational expense: 

  • The education cannot be part of a program that will qualify you for a new trade or business. This means that if you will now be able to enter a new profession that you could not perform work in before, the expense cannot be deducted. 
  • The education cannot be needed to meet the minimal educational requirements of your present trade or business. This means it if the work requires a masters degree, as the minimum education required to enter the profession, the masters degree cannot be a business deduction. 

The idea with this step is that the IRS expects you to pay for the education to enter into a trade, business or profession but once you are already in that business, you can deduct costs that maintain and enhance those skills and that will improve opportunities and income in that field. 

Tax court cases

It is not always clear what may qualify you for a "new" trade or business. To understand what will likely qualify we can look at tax court cases. Tax court cases represent situations where the IRS and a taxpayer disagreed, and a tax court judge was asked to decide. So pay attention to who won or lost the case. The IRS does not always win. However, it does also require time and often financial resources to fight the IRS all the way to tax court. 

Most of these cases do not set a precedent, meaning you cannot use them to argue your case if you end up in tax court yourself and a future tax court judge does not have to agree just because your case is similar to a prior case. However, they can give you some insight into where some tax court judges draw the line on this issue. 

O'Donnell vs. Commissioner

A CPA who obtained a law degree could not deduct the cost because even though he had no intention of actually practicing law, and only wanted the degree to further his work as a tax accountant, the degree "qualified" him to be an attorney, which is a different professional from accountant. 

Fields vs. Commissioner

A golf instructor deducted educational costs that could be counted toward a bachelor's degree. The deductions were denied. The tax court stated that if there are no previous undergraduate degrees, obtaining a first undergraduate degree will for sure qualify a taxpayer for a variety of new jobs and professions and therefore cannot be deducted.

Allemeier vs. Commissioner

A taxpayer was allowed to deduct costs to attain an MBA degree, even though the IRS had wanted to deny the deduction, because 1) the taxpayer stayed in the same company and promotions with more skill and ability were determined to not constitute a new trade or profession and 2) it was not required by the employer nor was it a requirement to do the jobs in the first place. It only enhanced his skill and furthered his promotability and pay.

The Internal Revenue Code has examples of deductible and non-deductible expenses as well here:  26 CFR § 1.162-5 - Expenses for education

Factors to consider 

When trying to determine if your education constitutes a new trade or business, consider the following factors. No one answer determines the outcome, however, these factors can sway the decision one way or another. 

Factors that suggest a continuing trade or business

  • You are already working in the field to which the education relates.
  • You will not qualify for a new professional license.
  • You will be serving the same client population or a more broad or narrow group/niche related to the same client population.
  • You will stay in the same business with the same name and website.

Factors that suggest you are qualified to enter a new trade or business

  • You cannot work in the field you want to enter without this education.
  • You will qualify to get a new professional license.
  • You will be performing a very different type of work afterward. 
  • You will start a new business, with a new name and website, or you plan to become an employee of someone else after attaining this education, doing something new that you could not have done before. 

The more clear and obvious that your education does NOT qualify you for a new trade or business, the more confident you can be in taking the deduction. The more in the grey area or the more it looks like it could possibly be a new trade or business, the more caution you want to have in taking the deduction. 

Cost you can deduct

If you determine the educational expenses meet the requirements to be deducted, the following type of costs can be deducted:

  • Tuition, books, supplies, lab fees, and similar items
  • Certain transportation and travel costs, and
  • Other educational expenses, such as the cost of research and typing

Travel costs cannot be deducted if the trip itself was primarily for personal reasons. To be deducted, the travel needs to be primarily for the the business/educational purpose, and only the business portion may be deducted. See the blog Business Related Travel: What Is Deductible for further information about deducting travel costs.

Educational employee benefit 

In addition to deducting educational costs for the business owner and to train employees to do their jobs, you can provide educational benefit to your employees for education costs they incur personally. The existing IRS educational assistance benefit permits employers to pay for employee education outside of work. The employee doesn’t pay income tax and the employer gets a deduction for up to $5,250/year per employee.
The CARES Act extended this benefit to include payment for employee student loans, not just tuition, and further legislation has extended it through 2025.

Primarily benefits employees

Owners that own 5% or more of the business can receive this benefit but maximum of 5% of the total benefit can go to the owner(s).
Example: Let’s say you have two employees with student loan debt and you pay each $5,250 or $10,500 in total. The owner could get a benefit of $550, which will not be taxed to the owner as income. Only 5% went to the owner ($550 / $11,050 = 4.98%). The business gets a total deduction of $11,050 but the owner is also out a lot of money. The owner could have had income of $11,050, paid tax, and spent the rest to pay down their own student loans.
An owner would need to spend $105,000 on employee educational benefits to get $5,250 for the owner, this would entail giving a full benefit to 19 employees and one owner. ($5,250 / $105,000 = 5%). 

Hiring incentive

This benefit can help hire employees who might take a lower salary or fee split if they are hired knowing they are getting this benefit. You wouldn’t necessarily have to pay more as the employer. Rather than hiring someone expecting to make $60k/year they could make $55k plus an up to $5,250 non-taxed educational benefit. Requirements are that:
  1. The business cannot give the employee a choice between $55k+$5,250 or $60k, meaning you can't let the employee take more cash and skip the benefit and
  2. The benefit has to be offered to all employees.

Family member employees

It can benefit family members who work for you. Children must be 21 years or older and not qualify to be a dependent on the owners tax return. So say you have a child who is a college senior, a grandchild, sibling or spouse in school and you hire them legitimately to work in your practice, you can offer them this benefit as long as they same benefit is offered to all employees.

Setting up the plan

If one wants to set this up for their business it needs to be a written educational assistance plan. It cannot benefit higher paid employees or owners more than it does regular or lower paid employees. Typically a plan like this would be written by an attorney or set up by a CPA or EA who is experienced in establishing these plan.

Bottom line

There are many types of educational expenses that can be taken as business deductions, including tuition, books, travel and other costs. To deduct the cost paid by the business the cost needs to maintain or improve the skills of the owner or employee, or be a requirement to maintain the position or job, such as with continuing education to maintain a professional license. The cost cannot qualify one for a new trade or business or be the minimum education needed to work in that field. Offering employee educational benefits can help you hire and retain employees, however, with all of these expenditures consider the way in which it will impact your revenue and profit as well. It may be worth the cost if it increases your profit in the long run or helps you grow your business. 

 

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