An MBA may be about to get much more expensive thanks to the tax reform bill now working its way through Congress.
The legislation currently under consideration in the U.S. House includes a provision that would eliminate what is known as the miscellaneous itemized deduction for work-related education. The deduction allows students to deduct the amount of tuition exceeding 2% of the student’s adjusted gross income for the year. On Friday (November 10), the Senate Finance Committee unveiled its version bill that includes a similar provision — making it all but certain that the deduction is living on borrowed time, Columbia Business School Professor Robert Willens says.
“The bill eliminates deductions for expenses incurred by an employee in carrying on his or her trade or business. As you know, education expenses are deductible only if, among other requirements, they are paid or incurred during the taxable year in carrying on a trade or business,” Willens tells Poets&Quants. “What both bills are doing are eliminating — unceremoniously and with great prejudice — any deduction for unreimbursed business expenses incurred by an employee. And in my experience 98% to 99% of MBAs are relying on that provision to justify deductions.”
THOUSANDS OF DOLLARS AT STAKE FOR INDIVIDUAL STUDENTS
The Tax Cuts and Jobs Act of 2017 may get a vote in the House as soon as Wednesday (November 15), and the GOP, which controls both chambers, has targeted January for the law to go into effect. President Donald Trump, eyeing his first legislative victory, is certain to sign any bill that emerges from Congress. For MBAs or those still studying to get their graduate degree, a major avenue for recompense of educational expenses may be about to close.
Under current law, to qualify for a deduction students must meet three requirements: first, that the education is either required by the person’s employer or by law to maintain the person’s job, status, or salary, and the education must serve a genuine business purpose for the employer; or that the education maintains or improves the skills needed in the person’s current work. The second requirement is that the education not be needed to meet the minimum educational requirements for the individual’s current trade or business. And finally, that the education not be part of a program of study that qualifies the individual for a new trade or business.
The new act threatens to eliminate five other tax breaks related to higher education: the Tuition and Fees deduction, the Hope credit, the Lifetime Learning Credit, Education Assistance Programs, and Qualified Tuition Reduction plans. But the miscellaneous itemized deduction for work-related education is the biggest and most frequently used tax break among them. Consider this scenario offered by William Perez, senior accountant at tax firm Visor: A student working as a product manager enrolls in an evening and weekend MBA program at a top-tier university. She earns $100,000 in salary, and paid $45,000 in tuition last year. Her federal income tax liability without the work-related education deduction was $18,738.
“But with the work-related education deduction, her federal income tax liability is $12,844,” Perez writes. “In other words, the work-related education deduction reduced her federal tax liability by $5,894.”
PREPAY NOW TO AVOID TAX HIT LATER
If the Tax Cuts and Jobs Act of 2017 passes, all may not be lost for students looking to offset their educational expenses, Perez says. He points to the American Opportunity Tax Credit, which the act proposes to expand to allow students to take a tax credit for their fifth year of post-secondary education expenses. “MBA students also might be able to seek tax-free reimbursement from their employer if their education qualifies as a working-condition fringe benefit,” Perez says.
Willens, however, is more circumspect about the odds of successfully deducting educational expenses if the act passes as currently drafted by both the House and Senate. “The only MBAs who would be permitted to deduct their educational expenses, assuming all of the other requirements for deductibility are met, are those who have been and will continue to be self-employed following graduation,” he says. “In my experience, this is just small sliver of the students, almost all of whom go on to become employees of large organizations, on Wall Street and elsewhere. I reported this information to my class last Thursday and the groans were audible.”
Willens says if they can afford it, students might want to pay for as much as they can before the new law takes effect as expected in January. “You can’t avoid the ultimate impact, but since it’s scheduled to go into effect for 2018, it might make sense to pay as much tuition as you possibly can in 2017,” he says. “One of the strategies people use is to prepay expenses in cases where tax rates are declining or in cases where items will no longer be deductible in the next year. Prepaying, if students can do it, would be a good idea.”
NEW LAW WILL ‘RAISE THE REAL COST OF AN MBA’
It’s important to remember, Perez says, that nothing is set in stone yet: The new act is not yet law, and anything can change between now and when Donald Trump affixes his signature. But Willens, at least, is not optimistic.
“It looks like the era of deducting education expenses has come to a screeching halt,” Willens says. “And it’s going to have a bad effect on business education across the board. With the mortgage interest deduction, people are worried that’s going to have a profound effect on the housing market. I would assume this would have maybe an equal effect on the MBA market.
“What this amounts to: It’s going to raise the real cost of an MBA. The after-tax cost of pursuing an MBA is going to increase, in some cases substantially.”