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Heading back to school? Know the tax rules

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in Centerpiece,Small Business Tax

It won’t be long before the kids start heading back to school. How about you? Maybe you’ve decided to take a refresher course in your specialty at a local college. Or you could be thinking about shifting gears and starting a new career path.

In some cases, you can deduct your business education expenses; in others, you can’t.

Strategy: Learn the tax rules inside-and-out. Then you can figure out how much, if anything, you can save in taxes.

To get a good handle on things, let’s start with the basics. You can deduct the cost of education as a business expense if you pass either one of these two tests:

  1. The education is required by your employer or by law to keep your current job.
  2. The education maintains or improves skills needed in your present work.

On the other hand, you can’t deduct any of your expenses, even if you qualify under either one of these two tests, if the education is needed to meet pre-existing minimum educational requirements of your current job, trade or business or if it qualifies you for a new trade or business or profession.

This sounds simple enough, but the lines often can be blurred in real-life situations. That is why this issue is frequently contested in the courts. More often than not, the IRS will prevail in these cases, especially if it claims the coursework qualifies you for a new trade or business.

Usually, you can’t deduct grad school expenses, even if you’re already in the same general line of work. But there have been a few notable exceptions. In a recent case, the Tax Court approved deductions for a registered nurse who incurred $15,000 in tuition expenses to attain a master’s degree in business administration. (Singleton-Clarke, TC Summary Opinion 2009-182)

How much can you deduct? There’s no dollar limit. Write off expenses such as tuition, books, laboratory fees, equipment and transportation between work and school. For instance, if you go to class directly after work, the cost of your travel —whether by car, bus or train—is deductible. But you can’t deduct the travel costs if you stop at home for a bite to eat.

If you qualify for deductions under the preceding standards and you’re a company employee, you must treat business education expenses as a miscellaneous itemized deduction item, subject to the usual “floor” of 2% of adjusted gross income (AGI).

Example: Your annual AGI is $100,000 and it costs you $2,500 in tuition and related expenses to take courses this fall. Absent any other miscellaneous expenses, your deduction for 2011 is limited to only $500 ($2,500 – 2% of $100,000).

A better approach, when it is available, is to have your company pay for the business education. Employer-paid reimbursements are generally deductible in full by the company and tax-free to employees.

Tip: Alternatively, if your company establishes an educational assistance plan (EAP), you may be able to receive up to $5,250 in benefits a year, free of income tax. Consult with an employee benefits pro for the details.

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