Here's what the IRS says:
To be deductible, your expenses must be for education that (1) maintains or improves your job skills or (2) that your employer or a law requires to keep your salary, status, or job. However, even if the education meets either of these tests, the education can't be part of a program that will qualify you for a new trade or business or that you need to meet the minimal educational requirements of your trade or business.
The issues from Tax Court:
1) If you quit your job to do the MBA program, you're not maintaining a trade, and you usually lose.
2) If you get a new job immediately after graduating, it's highly suggestive of the fact that it qualified you for a new trade or business.
3) If you had substantial management experience prior to the MBA program, you're more likely to win on the basis on improving your job skills and not qualifying for a new trade.
4) If you did not have substantial management experience prior to the MBA, you're likely to lose on the MBA deduction.
For insight on how the Tax Court views this, you probably want to look into some of the more serious and academic discussions on the topic and review a few important court cases. There's a good article called Solving the B-School Riddle that was published in the Georgetown Law Journal. It's a few years old, so it misses out on the most recent court cases, but still gives a very good rundown of the issues.
If you want insight on the IRS' position, you need only look at how often this issue is litigated. Think about the audit process. Taxpayer is chosen for audit. IRS disallows MBA deduction. Taxpayer then chooses: Accept determination OR move to Tax Court. Tax Court is costly, so many will simply accept the determination. The sheer number of cases actually making it to Tax Court on this issue suggests that the IRS frequently denies this deduction.
Large Unreimbursed Employee Business Expenses are a high risk area and an MBA deduction is a high risk item within this area. Generally, when an auditor is confronted with a "grey area," they deny the deduction. Without clear legal guidance, they do not have the authority to accept the deduction.
In addition to asking yourself whether your deduction is defensible, you should ask: 1) Are you prepared to defend it under audit. 2) Are you prepared to defend it in Tax Court.
I would take the deduction for myself because the answer to both of those questions is "Yes." I'll defend anything on my own tax return because I'm a CPA and it costs me nothing but time to do so. But when a massage therapist client recently asked me this question, I told her "No." Given the case history and her facts and circumstances, I could not possibly see how it would be a defensible position on her tax return.
