Can you deduct undergraduate college and MBA costs? As so often is the case with tax questions, the answer depends on specific circumstances. Here's the scoop.
No Business Write-Offs for Undergrad Costs, but Other Breaks Are Often Available
The Internal Revenue Service says an undergraduate college degree automatically prepares you for a new profession. Assuming that's true, the tax rules say costs to pursue a Bachelor of Arts (BA) or Bachelor of Sciences (BS) cannot be deducted as unreimbursed employee business expenses (on Form 2106) or as self-employed business expenses (on Schedule C, E or F). Unfortunately, the Tax Court has repeatedly agreed with the IRS on this issue. But don't give up -- other tax breaks may be available.
You may be eligible for either the American Opportunity tax credit (worth up to $2,500 per year for the first four years of college undergraduate work) or the Lifetime Learning credit (worth up to $2,000 per year for as many years as it takes to finish school).
To claim the American Opportunity credit, you must carry at least half of a full-time course load for at least one academic period that starts during the year in question. If you are unmarried, the credit is phased out between modified adjusted gross income (MAGI) of $80,000 and $90,000. For married joint-filers, the phase-out range is $160,000-$180,000.
There's no course-load requirement for the Lifetime Learning credit, but a much stricter income phase-out rule applies, and you must spend at least $10,000 on qualified expenses during the year to claim the maximum $2,000 benefit. If you are unmarried, the credit is phased out for 2011 between MAGI of $51,000 and $61,000. For married joint-filers, the 2011 phase-out range is $102,000-$122,000. (For 2010, the phase-out ranges were $50,000-$60,000 and $100,000-$120,000, respectively.)
For more details on both credits, see here.
Non-Business Deduction May Be Available
Finally, you may be eligible to claim the non-business deduction for up to $2,000 or $4,000 of qualified undergraduate college costs on Page 1 of Form 1040. You don't have to itemize to take this write-off. However, you cannot take it if you claim either the American Opportunity credit or the Lifetime Learning credit for the year in question. No double dipping. Also, the IRS says you must already have a high school diploma or GED to take the deduction.
The larger $4,000 deduction is available if your modified adjusted gross income (MAGI) is $65,000 or less or $130,000 or less if you are a married joint-filer. The smaller $2,000 deduction is available if you are unmarried with MAGI between $65,001 and $80,000 or married with MAGI between $130,001 and $160,000. If your MAGI exceeds the $80,000 or $160,000 ceiling (whichever applies), you get no deduction at all.
For more details on the non-business deduction, see here.
Business Write-Offs Are Often Allowed for MBA Costs, and Other Breaks May Be Available Too
The IRS has always argued that an MBA degree automatically trains you for a new profession. So according to the tax collector, you can never deduct MBA costs as unreimbursed employee business expenses or as self-employed business expenses. Thankfully, the Tax Court does not agree. It says business deductions are allowed if the MBA training maintains or improves skills used in your current job, profession or business. For example, if you are a CPA I think you can clearly deduct MBA costs under this standard.
However, business deductions cannot be claimed if the MBA courses are taken before or shortly after you are hired in order to meet pre-existing minimum educational requirements for your job. Ditto if the MBA trains you for a new profession. For example, if you are a self-employed illustrator who is pursuing an MBA at night in order to become a marketing consultant, you cannot write off the costs as a business expense because the MBA trains you for a new profession.
Lifetime Learning Credit
Qualified MBA costs are eligible for the Lifetime Learning tax credit, which can be worth up to $2,000 per year under the rules I explained earlier.
You may be eligible to claim the non-business deduction for up to $2,000 or $4,000 of qualified MBA costs on Page 1 of Form 1040 under the rules explained earlier. The deduction is not limited to undergrad costs.
What About Law School Costs?
The IRS claims that a law degree (JD) automatically trains you for a new profession, and the courts agree -- even if you have no intention of actually working as a lawyer. So you can never deduct law school costs as unreimbursed employee business expenses or as self-employed business expenses. However, the expenses can potentially qualify for the Lifetime Learning credit or the non-business deduction under the rules explained earlier.
Costs to obtain an LLM (Masters in Law degree) should fall under the same rules as MBA costs, because an LLM does not allow you to actually practice law.
What If the Same Expenses Qualify for Several Breaks?
One of the problems with our existing array of education tax breaks is they can overlap. For instance, you could conceivably claim the Lifetime Learning credit or the non-business deduction for the same undergraduate college costs. You could conceivably claim a business write-off or the non-business deduction for the same MBA costs. The only sure way to tell which overlapping break is best is by filling out your return one way and then the other. Use Form 8863 (Education Tax Credits) to calculate the American Opportunity or Lifetime Learning credit. Use Form 8917 (Tuition and Fees Deduction) to calculate the non-business deduction.