Getting Smart on Uncle Sam’s Dollar

The quotation I keep on my desk from Benjamin Franklin says, “An investment in knowledge pays the best interest.” Savvy business owners know that learning is a lifetime affair. Fortunately, there are many federal income tax breaks to help defray the cost of your ongoing education.

Lifetime learning credit

If you continue to pursue formal education beyond the undergraduate level, you may be eligible to claim a tax credit for tuition, fees, and certain other qualified expenses. Each dollar of the tax credit reduces your tax bill by one dollar. The lifetime learning credit is up to $2,000 (20% of the first $10,000 of qualified costs you spend).

The only hitch is that the credit may be reduced or become unavailable to you if your income is too high. The full credit can be claimed in 2012 if your modified adjusted gross income (MAGI), which essentially is income before exemptions and the standard deduction or itemized deductions, is no more than:

• $52,000 for singles
• $104,000 for married persons filing jointly

The credit phases out for singles with MAGI between $52,000 and $62,000 and joint filers with MAGI between $104,000 and $124,000; no credit can be claimed if MAGI exceeds these limits.

Deduction for education costs

If you take courses or training to improve your professional or work skills, you can treat the costs as a deductible business expense. These courses include required continuing education for your profession — whether taken in person, online, or as self-study. Even courses taken in resort locations may be deductible (as well as the travel and lodging costs for attendance).

If you pay out-of-pocket for your education costs and the business does not reimburse you, then where you deduct the costs depends on how your business is organized.

• If your company is incorporated, you can only deduct unreimbursed employee business expenses (your education costs) as a miscellaneous itemized deduction. Totals must exceed 2% of your adjusted gross income to receive any benefit from the write-off. What’s more, if you are subject to the alternative minimum tax, which affects many higher income taxpayers (especially those in high tax states), then you effectively lose any tax benefit from education costs.
• If your company is unincorporated so that you are self-employed, you can deduct education costs. Sole proprietors deduct education costs on Schedule C of Form 1040; partnership and limited liability company members deduct the costs as a subtraction from their share of business income reported on Schedule E of Form 1040.

Caution: No deduction can be claimed for education costs that qualify you for a new trade or business. Thus, the costs of law school and bar preparation expenses are not deductible because a law degree qualifies a person to practice law (whether or not this is the intention). The cost of an MBA may be deductible; there’s a lot of litigation on this point, but many taxpayers have been successful in showing that this degree is not a new trade or business.

Even better than deducting education costs is having the business cover them. In this case, costs are deducted on the business return. If the business is incorporated, there are two ways to do this without triggering taxable income to you (as an owner-employee of the corporation):

• The company can adopt an education assistance plan to pay up to $5,250 annually for any courses, whether or not job related. This offering must be available to all employees on a nondiscriminatory basis, so, as a practical matter, this plan may not be helpful in small companies because of nondiscrimination requirements in the tax law.
• The company can pay for any job-related courses; this is called a working condition fringe benefit. There is no dollar limit on the costs that can be reimbursed on a tax-free basis.

An unincorporated business can simply pay your education costs or reimburse you for them; no formalities are required other than substantiating the costs.

Tax-free educational options

You don’t have to spend a penny to learn more about finance, marketing, taxes, or other areas to help your business. There are many free online sites to smarten you up. Because they’re free, there is no tax issue involved.

Here are some resources for free learning:

• Colleges offering unaccredited online courses, including such prestigious schools as Harvard, MIT, Princeton, Stanford, and the University of Pennsylvania.
• Online training from government agencies, including the IRS, OSHA, and the SBA.

Final thoughts

There are many other education-related tax breaks and you usually have to choose the one that provides you with the most tax savings. These breaks all have different rules, such as income limits and qualifying education costs. You can learn more from IRS Publication 970, Tax Benefits for Education. When in doubt, ask your tax advisor whether the education you want to pursue can be pursued on a tax-advantaged basis.

About the Author

Barbara Weltman is an attorney, prolific author with such titles as J.K. Lasser’s Small Business Taxes and The Complete Idiot’s Guide to Starting a Home-Based Business, and trusted professional advocate for small businesses and entrepreneurs. She is also the publisher of Idea of the Day® and monthly e-newsletter Big Ideas for Small Business® and host of Build Your Business Radio. She has been included in the List of 100 Small Business Influencers for 2011 and 2012. Follow her on Twitter: @BarbaraWeltman.