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Tax Court Rules Against IRS in Deductibility of MBA Tuition

JUN. 16, 2021

Yishi Zuo v. Commissioner

DATED JUN. 16, 2021

Yishi Zuo v. Commissioner

Yishi Zuo
Commissioner of Internal Revenue

United States Tax Court


Pursuant to Rule 152(b), Tax Court Rules of Practice and Procedure, it is

ORDERED that the Clerk of the Court shall transmit to petitioner and to respondent a copy of the pages of the transcript of the proceeding of the above case before Special Trial Judge Peter J. Panuthos during the New Orleans, Louisiana trial session of the Court on June 16, 2021, containing the Court's oral findings of fact and opinion. In accordance with the oral findings of fact and opinion, the decision will be entered for petitioner.

(Signed) Peter J. Panuthos
Special Trial Judge

Bench Opinion by Judge Peter J. Panuthos

June 16, 2021

THE COURT: The Court has decided to render oral findings of fact and opinion in this case and the following represents the Court's oral findings of fact and opinion. The oral findings of fact and opinion shall not be relied upon as precedent in any other case.

This case was heard as a Small Tax Case pursuant to the provisions of Section 7463 of the Internal Revenue Code in effect when the petition was filed. This bench opinion is made pursuant to the authority granted by section 7459(b) of the Internal Revenue Code and Tax Court Rule 152. Rule references in this opinion are to the Tax Court Rules of Practice and Procedure, and section references are to the Internal Revenue Code, as amended and in effect at all relevant times.

By notice of deficiency dated December 31, 2018, respondent determined a deficiency in petitioner's Federal income tax in the amount of $6,083 as well as an accuracy-related penalty under section 6662(a) in the amount of $1,216.60 for taxable year 2016.

The issue to be decided is whether petitioner is entitled to deduct $24,412 on his 2016 Federal income tax return for expenses paid that relate to his pursuit of a Master of Business Administration (hereinafter MBA) degree. Some of the facts have been stipulated, and we incorporate the stipulation of facts by this reference.

On the evidence before us, and using the burden-of-proof principles explained below, the Court finds the following facts.


Petitioner resided in the Commonwealth of Massachusetts at the time he filed the petition.

Petitioner received an undergraduate degree in business administration from The University of California, Berkeley in 2011.After receiving his bachelor's degree, petitioner worked as an investment banking analyst at Goldman Sachs in San Francisco, California for two years. In September 2013, he left Goldman Sachs and began employment as an investment analyst at Solstein Capital, LLC (hereinafter Solstein Capital), a hedge fund located in San Francisco. While working full-time at Solstein Capital, petitioner simultaneously pursued two entrepreneurial technology ventures. In 2014, petitioner founded Wikispective, Inc. (hereinafter Wikispective), which petitioner describes as a project similar to Wikipedia. In 2015, petitioner co-founded 36Names LLC (hereinafter 36Names), a domain name leasing company. Petitioner filed articles of organization for 36Names with the Secretary of State of California on June 12, 2015. He actively worked to grow 36Names throughout 2016. The business registration for 36Names with the State of California was canceled on September 11, 2017. Petitioner's records indicate that he invested $21,905 of his own funds for startup costs for Wikispective and 36Names.

In May of 2016, petitioner left his position at Solstein Capital to pursue a MBA degree from the Massachusetts Institute of Technology (hereinafter MIT). He continued to work on 36Names while traveling over the summer of 2016 and after enrolling at MIT in the fall of 2016. While studying at MIT, petitioner and some of his fellow MBA students organized a company called DeepBench LLC (hereinafter DeepBench). Petitioner served as the CEO of DeepBench starting in October of 2016. DeepBench is a company organized under the laws of the State of Delaware that helps connect its clients to expert advisors through its software platform. Petitioner left his position at DeepBench in October 2020 to found and serve as the managing partner for a company called Optionality Partners (a consultancy that advises entrepreneurs on starting businesses from scratch).

Petitioner timely filed a 2016 Form 1040, U.S. Federal Income Tax Return, and claimed a $24,412 deduction for his MBA degree expenses as unreimbursed employee expenses on Schedule A, Itemized Deductions. Petitioner also reported income from DeepBench on his 2016 Schedule C, Profit or Loss From Business. The parties do not dispute that petitioner paid the MBA degree expenses for which he claimed a deduction on his 2016 tax return. Petitioner hired a professional income tax return preparer to prepare his 2016 Form 1040.

In the notice of deficiency respondent disallowed the entirety of petitioner's claimed deduction related to his MBA degree expenses. The notice of deficiency also determined an accuracy-related penalty pursuant to section 6662(a).


Burden of Proof

In general, the Commissioner's determination as set forth in a notice of deficiency is presumed correct, and the taxpayer bears the burden of proving that the determination is in error. Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933). Pursuant to section 7491(a), the burden of proof as to factual matters shifts to the Commissioner under certain circumstances. Petitioner did not allege or otherwise show that section 7491(a) applies. See sec. 7491(a)(2)(A) and (B).

Therefore, petitioner bears the burden of proof. See Rule 142(a).

Deduction for Education Expenses

As a general rule, section 162(a) authorizes a deduction for "ordinary and necessary expenses paid or incurred * * * in carrying on any trade or business". 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. Sec. 1.162-5(a), Income Tax Regs. Section 162 requires a taxpayer to be presently engaged in a trade or business in order for education expenses to be deductible. See Link v. Commissioner, 90 T.C. 460, 463-464 (1988), aff'd, 869 F.2d 1491 (6th Cir. 1989); Schneider v. Commissioner, T.C. Memo. 1983-753. The regulations disallow a deduction for education expenses for: (1) education required to meet the minimum requirements of a taxpayer's trade or business or (2) a program of study that qualifies a taxpayer in a new trade or business. Sec. 1.162-5(b)(2) and (3), Income Tax Regs.

When evaluating whether education expenses qualify the taxpayer for a new trade or business, the Court uses a "commonsense approach" comparing "the types of tasks and activities which the taxpayer was qualified to perform before the acquisition of a particular title or degree, and those which he is qualified to perform afterwards." Glenn v. Commissioner, 62 T.C. 270, 275 (1974); see Weiszmann v. Commissioner, 52 T.C. 1106, 1110 (1969), aff'd, 443 F.2d 29 (9th Cir. 1971). An education that merely refines a taxpayer's existing skills does not qualify him for a new trade or business. Robinson v. Commissioner, 78 T.C. 550, 557 (1982). We have held that a taxpayer may deduct the cost of an MBA degree as an unreimbursed employee expense if his studies improve on a preexisting skill such as management skills. Allemeier v. Commissioner, T.C. Memo. 2005-207, slip op. at 13-14; Sherman v. Commissioner, T.C. Memo. 1977-301, 36 T.C.M. (CCH) 1191, 1193-1194 (1977). A taxpayer is in the same trade or business 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. See Sherman v. Commissioner, 36T.C.M. (CCH) AT 1193-1194.

Petitioner argues that he is entitled to a deduction for his unreimbursed employee expenses because he was an established entrepreneur before, during, and after his pursuit of an MBA degree. At trial he testified that he continued his entrepreneurial ventures both during his temporary unemployment over the summer of 2016 and concurrently with his MBA education. He therefore argues that although his MBA degree helped him to refine his skills, it did not qualify him for a new trade or business. Respondent contends that petitioner's MBA degree "qualified" him for a new trade or business in that developed his skills as an entrepreneur. Respondent argues that these skills were not required to be successful in petitioner's employment with Solstein Capital.

Black's Law Dictionary (11th ed. 2019), defines an entrepreneur as "[s]omeone who initiates and assumes the financial risks and accepts the rewards of a new enterprise and who usu[ally] undertakes its management." This definition is similar to that in the Merriam-Webster Online Dictionary (2021), which defines an entrepreneur as "one who organizes, manages, and assumes the risks of a business or enterprise." Respondent agrees that there are no certification or licensing requirements to be referred to as an entrepreneur and we are not aware of any Federal or state certification or licensing requirements.

We are satisfied that petitioner was qualified in the trade or business of being an entrepreneur before enrolling in the MBA program at MIT on the basis of the time and money he had previously spent founding, organizing, and assuming the financial risks of his two entrepreneurial ventures, Wikispective and 36Names. Further, petitioner had likely developed significant business acumen that was useful in pursuing these ventures while obtaining an undergraduate degree in business administration and working as an investment analyst at Goldman Sachs and Solstein Capital. Petitioner continued to develop his entrepreneurial skillset when he helped found and served as the CEO of DeepBench starting in 2016.

Although petitioner's business courses at the MIT MBA program may have honed his leadership, communication, organization, and other skills necessary to run a successful business, they did not "qualify" him for a new trade or business as an entrepreneur. Rather, they maintained and refined skills he was already using in his current business. See Allemeier v. Commissioner, slip op. at 13-14; Sherman v. Commissioner, 36 T.C.M. (CCH) at 1193-1194; sec. 1.162-5(b)(3), Income Tax Regs.

A taxpayer may be engaged in a trade or business, although not working, if he was previously involved in and actively sought to continue in that trade or business while pursuing a defined degree program related to his or her line of work. Ford v. Commissioner, 56 T.C. 1300, 1304 (1971), aff'd, 487 F.2d 1025 (9th Cir. 1973); Hitt v. Commissioner, T.C. Memo. 1978-66, 37 T.C.M. (CCH) 333, 334-335 (1978). The taxpayer must clearly intend to seek employment in the same trade or business. Goldenberg v. Commissioner, T.C. Memo. 1993-150, 1993 WL 101367, at *4; see Corbett v. Commissioner, 55 T.C. 884, 887-888 (1971).

Beginning in May of 2016 petitioner was not working for an employer in the fields of finance or business. He testified, however, that he continued to work on 36Names throughout the summer and fall of 2016. Although he also testified that he was traveling during the summer of 2016, petitioner clearly intended to continue his professional career as an entrepreneur. See Corbett v. Commissioner, 55 T.C. at 887-888; Goldenberg v. Commissioner, 1993 WL 101367, at *4. We are satisfied that the period from May 2016, when petitioner left his position at Solstein Capital, through October 2016, when petitioner founded DeepBench, was a transition period during which he actively sought to continue in the trade or business of entrepreneurship while pursuing a defined graduate degree program. We conclude that petitioner may be considered to have been carrying on his trade or business during this time. See Ford v. Commissioner, 56 T.C. at 1304; Hitt v. Commissioner, 37 T.C.M. (CCH) at 334-335.

We hold that petitioner's pursuit of an MBA degree improved and maintained skills related to his established trade or business as an entrepreneur and that he is therefore entitled to a deduction for education expenses associated with that degree under section 162.

Accuracy-Related Penalty

Section 6662(a) and (b)(1) and (2) imposes an accuracy-related penalty on any portion of an underpayment of Federal tax that is attributable to the taxpayer's "[n]egligence or disregard of rules or regulations" or "substantial understatement of income tax. "We question respondent's continuing efforts to pursue the accuracy-related penalty in this matter given the nature of the petitioner's background and his presentation of facts disputing respondent's determination. In any event, we have concluded that petitioner is entitled to deduct the full amount of the MBA expenses claimed on his tax return, and there is no substantial understatement of income tax. See sec. 6662(d)(1)(A). Therefore, we also hold for petitioner with respect to the section 6662(a) accuracy-related penalty.

To reflect the foregoing, decision will be entered for petitioner.

This concludes the Court's oral findings of fact and opinion in this case.

(Whereupon, at 3:22 p.m., the above-entitled matter was concluded.)

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