United States Tax Court Decision for the Week – You be the Judge

A recent Tax Court decision was reported that may be of interest to individuals potentially dealing with tax litigation. J. Frank Best, Certified Public Accountant and United States Tax Court Practitioner, as a litigator, works to stay current on all IRS decisions concerning tax litigation to ensure we are fully informed and prepared for our clients.

Wharton M.B.A. Expenses Deducible as Unreimbursed Employee Expenses

The Tax Court held that a taxpayer could deduct the cost of a Wharton M.B.A. degree as an unreimbursed employee expense because his studies improved on preexisting skills and did not, as the IRS argued, qualify him for a new trade or business. Thus, the taxpayer could deduct the education expenses as miscellaneous itemized deductions on Schedule A, Itemized Deductions, to the extent the expenses exceeded 2 percent of his adjusted gross income. Long v. Comm’r, T.C. Summary 2016-88.

Background

From March 2005 to May 2011, Tao Long worked for Broadcom Corp., a semiconductor company in Silicon Valley that makes computer chips. He started as a design engineer and was promoted to the positions of product marketing manager, senior product marketing manager, and product line manager. While he was working at Broadcom, Long passed levels I, II, and III of the Chartered Financial Analyst (CFA) Institute exam. At Broadcom, Long’s responsibilities in the product marketing department included market, product, and trend analysis, creating proposals about products for upper management that included financial analysis, and managing teams that developed and introduced products to the market.

In May 2010, Long enrolled in the M.B.A. program at the Wharton School, University of Pennsylvania (Wharton M.B.A. program). He graduated with honors in April 2012. His coursework for the program was finance and management-related; he took courses such as financial accounting, new product management, and corporate valuation.

Broadcom had an educational assistance policy providing financial reimbursement, up to $5,250 per employee per calendar year, for tuition, fees, books, supplies, and equipment. To be eligible for reimbursement an employee had to be active (not on an unpaid leave of absence), working full time, and have preapproval of each course. Employees had to request the reimbursement within 60 days after the completion of the course. An employee who terminated his employment within one year of receiving reimbursement was required to repay the reimbursement in full at the time of termination.

In May 2011, Long resigned from Broadcom and, in June 2011, Long began a full-time summer internship in the investment division of Barclays Capital, an investment bank. He worked for Barclays Capital from June through August 2011. Long did not work again until January 2012 when he began working at Connective Capital Management, LLC (Connective Capital), as a senior research analyst in nearby Palo Alto, California. The job posting under which Long applied stated that the senior research analyst would “lead research activities in technology and industrial sectors, with responsibility for all aspects including idea generation, technology/product review, business model and competitive analysis, primary research utilizing Connective’s industry network, valuation modeling, and risk management.” Requirements listed for the senior investment analyst position included technology-related industry experience, a financial and/or engineering background, and “[t]echnical undergraduate and MBA from top university preferred.”

Deductions Taken for Wharton M.B.A. Costs on 2010 and 2011 Tax Returns

Long reported salary income of $527,860 and $117,888 for 2010 and 2011, respectively. He claimed deductions for tuition expenses for attending the Wharton M.B.A. program. Long sought to deduct $86,100 and $84,450 for amounts paid to Wharton for tuition, fees, books, supplies, and room and board for tax years 2010 and 2011, respectively. While Long initially tried to tie the Wharton M.B.A. expenses to a real estate activity in which he was engaged, he subsequently sought to deduct the costs as unreimbursed employee expenses.

Education Expenses as Unreimbursed Employee Expenses

Generally, Code Sec. 162(a) allows a deduction for ordinary and necessary expenses paid or incurred in carrying on any trade or business. Under Reg. Sec. 1.162-5(a), an individual’s expenditures for education are deductible as ordinary and necessary business expenses if the education maintains or improves skills required in his employment or other trade or business. Generally, the performance of services as an employee constitutes a trade or business. A taxpayer may deduct unreimbursed employee expenses only as miscellaneous itemized

deductions on Schedule A, Itemized Deductions, and then only to the extent such expenses exceed 2 percent of the individual’s adjusted gross income. Itemized deductions may be limited under the overall limitations on itemized deductions under Code Sec. 68 and may have an alternative minimum tax implication under Code Sec. 56(b)(1)(A)(i).

Under Reg. Sec. 1.162-5(b)(2) and (3), no deduction for the following education expenses are allowed:

(1) those incurred to meet the minimum educational requirement for qualification in a taxpayer’s trade or business; and

(2) those which qualify a taxpayer for a new trade or business.

IRS’s Position

The IRS did not question whether Long’s M.B.A. degree was incurred to meet the minimum educational requirement of his trade or business. Instead, the IRS argued that the Wharton M.B.A. qualified Long for a new trade or business because it qualified him for the senior research analyst position with Connective Capital. The IRS highlighted the fact that the Connective Capital job description said that someone with an M.B.A. was preferred as evidence that the M.B.A. qualified Long for a new trade or business.

Tax Court’s Analysis

The Tax Court began its analysis by observing that an education that merely refines a taxpayer’s existing skills does not qualify him for a new trade or business. Citing its decisions in Allemeier v. Comm’r, T.C. Memo. 2005-207, and Sherman v. Comm’r, T.C. Memo. 1977-301, the court noted that a taxpayer may deduct the cost of an M.B.A. degree as an unreimbursed employee expense if the taxpayer’s studies improve on preexisting skills, such as management skills. A taxpayer is in the same trade or business, the court said, if he is still in the same general field and still using the same skills; for example, moving from one position to another that also uses management, administrative, and planning skills.

The court was satisfied that Long was qualified in the same trade or business both before and after the M.B.A. program. He was qualified in financial analysis, the court said, through his studies and personal investment experience before enrolling in the M.B.A. program in May 2010. The court also noted that Long had passed all three levels of the CFA exam by June 2009, spending an estimated 900 hours learning about investment tools and portfolio management to prepare for the exam. Long also acquired managerial and financial analysis skills through his employment and continued to develop those skills during the years in issue, the court said. Long developed managerial skills in his role at Broadcom by managing teams that would bring a product to market. The court concluded that Long’s management and finance courses in the Wharton M.B.A. program did not qualify him for a new trade or business, but rather developed skills he was already using in his current trade or business.

With respect to Connective Capital’s job description saying that an M.B.A. was preferred, the court said this was a mere preference, and Long had other qualifications listed in the job description, including personal and professional investment experience and a technical undergraduate degree.

With respect to Long’s unemployment for four months in 2011, the court said that it was clear that he intended to find another position and continue his professional career. Those four months, the court noted, were a transition period during which Long was actively seeking employment while pursuing a defined graduate degree program. As a result, the court concluded that Long was still carrying on his trade or business during this time.

The court then considered whether Long could deduct his educational expenses as an unreimbursed employee expense. In order to deduct employee expenses, the court noted that a taxpayer must not have received reimbursement or been eligible to receive reimbursement. The court observed that Long met the requirements of Broadcom’s educational assistance policy and thus may have been eligible for reimbursement of up to $5,250 per year for his Wharton M.B.A. expenses. However, the court said, since Long terminated his employment in May 2011, less than a year from the periods in which he was eligible for reimbursement, he would have had to immediately repay any reimbursement the day he resigned. Thus, the Tax Court concluded that Long’s decision to not seek reimbursement from Broadcom for his education expenses incurred during January 2010 through June 2011 was reasonable.

The court held that Long was entitled to deduct the costs of his Wharton M.B.A. program for 2010 and 2011 as unreimbursed employee expenses on Schedule A, subject to the applicable limitations on such expenses.

United States Tax Court Decision for the Week – You be the Judge

A recent Tax Court decision was reported that may be of interest to individuals potentially dealing with tax litigation. J. Frank Best, Certified Public Accountant and United States Tax Court Practitioner, as a litigator, works to stay current on all IRS decisions concerning tax litigation to ensure we are fully informed and prepared for our clients.

Modified Child Support Order Didn’t Contradict Taxpayer’s Claim That He Was Custodial Parent

The United States Tax Court held that a taxpayer was entitled to take dependency exemptions, the earned income tax credit, and child tax credits for the year at issue. The court found that the IRS’s argument that the taxpayer wasn’t the custodial parent and wasn’t entitled to the exemptions and credits was entirely based on a child support order effective after the year at issue, and thus inapplicable. The court also determined that the taxpayer had reasonable cause for incorrectly claiming head of household filing status and thus was not liable for penalties assessed by the IRS. Tsehay v. Comm’r, T.C. Memo. 2016-200.

Background

Yosef Tsehay, whose first language is not English, worked as a custodian at a community college in Washington. He and his wife were married in 2001 and over the years their relationship was “on-again, off-again.” During 2013, the two were married and living together with their five children in a public housing apartment. Tsehay’s wife was responsible for paying the rent on the public housing unit, and he paid for food and other expenses of his family. In 2014, the couple separated, and during 2015 they were undergoing divorce proceedings.

Although Tsehay paid a tax return preparer to prepare his return, Tsehay electronically filed the 2013 Form 1040A himself. On the return, he claimed: (1) dependency exemption deductions for four children; (2) the earned income tax credit (EITC) for three children; (3) the child tax credit (CTC) for four children; and (4) head of household filing status. He did not attach a Form 8332, Release/Revocation of Release of Claim to Exemption for Child by Custodial Parent, or a statement conforming to the substance of a Form 8332, to his Form 1040A for tax year 2013.

Following an audit, the IRS disallowed Tsehay’s claimed dependency exemption deductions, earned income tax credit, and child tax credit for 2013. The IRS also changed his filing status from head of household to single and determined an accuracy-related penalty under Code Sec. 6662(a).

Analysis

Under Code Sec. 151(c), an individual is allowed an exemption deduction for each “dependent,” which is generally defined as a qualifying relative or a qualifying child. In addition, taxpayers are entitled to claim the EITC under Code Sec. 32 and the CTC under Code Sec. 24 for qualifying children. Under Code Sec. 152(c), to be a qualifying child of the taxpayer, the child must have had the same principle place of above as the taxpayer for more than one-half of the tax year.

Under Code Sec. 2(b), a taxpayer can file as a head of household if the taxpayer is unmarried, has paid more than half the cost of keeping up a home for the year, and a qualifying person has lived with the taxpayer for more than half the year.

The Tax Court noted that the IRS’s determinations stemmed from its records showing that Tsehay was not the custodial parent of his minor children and from his failure to attach a copy of Form 8332 or its equivalent to his return. The IRS provided a copy of a child support order to establish that Tsehay was in fact a “noncustodial parent.” However, the court stated, the child support order was entered August 3, 2015, and thus did not apply for the year at issue. The court determined Tsehay had sufficiently established that he and his wife were married during 2013, and thus a Form 8332 to claim dependency exemptions was not required.

The court noted the children claimed on Tsehay’s return as dependents had the same principal place of abode as he did for more than one-half of the year at issue and were his qualifying chidlren, and determined that he was entitled to the dependency exemption deductions claimed on his 2013 return. In addition, because he had “three or more” qualifying children for tax year 2013, the court determined he was entitled to the earned income credit and to child tax credits and the additional child tax credits claimed.

With regard to his filing status, Tsehay explained to the court that because he and his wife had separated by the time he was ready to file his 2013 tax return, he had asked his preparer to file for him as “married filing separately.” The court noted that the preparer erroneously filed his return as “head of household.” Because Tsehay was married for 2013, the court stated he could not qualify for head of household filing status, and noted he also was not eligible to file as single as claimed by the IRS. Instead, the court said, his correct filing status for 2013 was in fact married filing separately.

With regard to the accuracy related penalty, the court observed that Tsehay had a language barrier, sought and relied on professional advice, and was separated from his wife when he filed his return. Under those circumstances, the court stated, Tsehay had reasonable cause and acted in good faith in filing his returns, and declined to impose penalties.

United States Tax Court Decision for the Week – You be the Judge

A recent Tax Court decision was reported that may be of interest to individuals potentially dealing with tax litigation. J. Frank Best, Certified Public Accountant and United States Tax Court Practitioner, works to stay current on all IRS decisions concerning tax litigation to ensure we are fully informed and prepared for our clients.

IRS Collection Actions Were Abuse of Discretion Where the Settlement Officer Used Wrong Address: In Talbot v. Comm’r, T.C. Memo. 2016-191, the Tax Court determined that an IRS settlement officer (SO) abused her discretion in sustaining a levy and notice of federal tax lien for three of a taxpayer’s seven tax years because she had failed to properly verify that deficiency notices had been mailed to the taxpayer’s last known address for those years. The court noted the SO relied solely on the IRS’s certified mailing list, which contained an incorrect address for the taxpayer.

ROBERT TALBOT, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent

United States Tax Court Decision for the Week – You be the Judge

Collection Action Against Couple Was Proper, United States Tax Court Says

A recent Tax Court decision was reported that may be of interest to individuals potentially dealing with tax litigation. J. Frank Best, Certified Public Accountant and United States Tax Court Practitioner, works to stay current on all IRS decisions concerning tax litigation to ensure we are fully informed and prepared for our clients.

The United States Tax Court, in a summary opinion, held that the IRS didn’t abuse its discretion in sustaining a collection action against a couple that reported no tax liability and claimed deductions for charitable contributions, the business use of their home, and $473,309 in casualty or theft losses, finding that the couple failed to participate in their Collection Due Process hearing.

ROBERT CARTER, JR. AND LOLA CARTER,
Petitioners
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent

T.C. Summ. Op. 2016-38

United States Tax Court Decision for the Week – You be the Judge

No Abuse of Discretion by Settlement Officer; the IRS Levy is Sustained

The United States Tax Court sustained a proposed levy action against an individual who claimed her 1991 bankruptcy discharge relieved her of paying future taxes; the court upheld the IRS’s determinations regarding her underlying tax liabilities and found that the settlement officer didn’t abuse his discretion in sustaining the collection action.

A recent Tax Court decision was reported that may be of interest to individuals potentially dealing with tax litigation. J. Frank Best, Certified Public Accountant and United States Tax Court Practitioner, works to stay current on all IRS decisions concerning tax litigation to ensure we are fully informed and prepared for our clients.

GINN DOOSE A.K.A.VIRGINIA DOOSE,
Petitioner
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent

T.C. Memo. 2016-89