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Tax Court Denies Deductions for U.S. Legal Education of Attorney Licensed Abroad.

(Parker Tax Publishing September 1, 2015)

The educational expenses incurred by an attorney licensed to practice law in Germany to obtain a U.S. law degree were not deductible because the education did not maintain or improve skills required in his trade or business. O'Connor v. Comm'r, T.C. Memo. 2015-155.

Background

From April 1998 to July 2004, Mark Tracy, a U.S. citizen, attended the University of Heidelberg in Germany as a law student. To practice law in Germany, an individual must complete various requirements, including passing two state exams. After completing the written section of these exams, Tracy moved to Salt Lake City, Utah, to complete a three-month elective station of his German legal training at a law firm. In June 2007, Tracy completed all of the necessary requirements and was licensed to practice law in Germany. Also in 2007, Tracy became a project manager of a multimillion-dollar residential building project in Salt Lake City.

In 2009, while still living in Utah, Tracy started law school at the University of San Diego. He traveled back and forth from Salt Lake City to San Diego, California, while completing his degree. Tracy did not work and did not receive any Forms W-2 during 2010 and 2011. He received his juris doctor (J.D.) in 2012. In February 2014, Tracy sat for, and passed, the bar exam in New York.

Tracy and his wife attached Forms 2106-EZ, Unreimbursed Employee Business Expenses, to their 2010 Form 1040X and 2011 Form 1040 and deducted travel, meals and entertainment, and other business expenses related to Tracy's legal education. The IRS disallowed those deductions and assessed accuracy-related penalties under Code Sec. 6662(a).

Analysis

Under Reg. Sec. 1.162-5(a), educational expenses are considered ordinary and necessary business expenses if the education:

(1) maintains or improves skills required by the individual in his employment or other trade or business, or

(2) meets the express requirements of the individual's employer, or the requirements of applicable law or regulations, imposed as a condition to the retention by the individual of an established employment relationship, status, or rate of compensation.

Such expenses are deductible only if the taxpayer is established in the trade or business at the time he or she pays or incurs the expense. The taxpayer must show that the educational expense is directly and proximately related to the skills required in his trade or business.

The IRS argued that the facts in Tracy's case were similar to those in Horodysky v. Comm'r, 54 T.C. 490 (1970), where the Tax Court disallowed deductions for expenses related to the taxpayer receiving a law degree because the educational expenses were not required for the taxpayer to maintain his skills or to retain his position because he was not yet an admitted as an attorney at the time he incurred the expenses.

Tracy argued that his situation was different because New York, where he passed the bar exam in 2014, allows foreign-trained lawyers to sit for the bar exam without completing a legal education program in the United States. Therefore, he contended, he was not entering into a new trade or business. The IRS and Tracy stipulated that Tracy met the minimum requirements of the legal profession in Germany. According to Tracy, his educational expenses were deductible under Code Sec. 162 as long as he was active in any trade or business.

The Tax Court upheld the IRS assessment and denied the legal expense deductions. According to the Tax Court, the fact that Tracy met the minimum requirements of the legal profession in Germany did not mean that he automatically qualified to be a legal professional in the United States. In New York, the court noted, foreign trained applicants may sit for the bar exam only if certain requirements are fulfilled. Because Tracy did not receive an LL.M. from an American Bar Association approved law school, he would be required to prove that his legal studies program was substantially equivalent in duration to the legal education provided by an American Bar Association approved law school in the United States, and in substantial compliance with the instructional and academic calendar requirements provided by New York. Additionally, the court said, Tracy would have to show that the law of Germany is based on principles of English common law and that his legal studies program was the substantial equivalent of the legal education provided by an American Bar Association approved law school in the United States. Because Tracy did not provide any evidence to show that these requirements had been met and that he was entitled to sit for the New York bar exam before he completed his J.D., the court found that Tracy had not established himself in the legal profession in the United States, and his educational expenses were incurred in association with entering into a new trade or business.

The court then addressed Tracy's argument that the educational expenses were deductible under Code Sec. 162 as long as he was active in any trade or business. The court noted that, while Tracy was a law student in 2010 and 2011 and was also involved with managing a residential building project, and he may have been involved in bringing a legal action under the False Claims Act, the record was unclear regarding when Tracy undertook these activities. Even assuming that he was involved in these activities during 2010 and 2011, the court found that Tracy did not show any connection between these activities and his legal education.

Finally, the Tax Court concluded that Tracy failed to show that he had a reasonable basis for deducting the expenses associated with his legal education. Thus, the court sustained the assessment by the IRS of the penalties under Code Sec. 6662.

For a discussion of the requirements to deduct educational expenses, see Parker Tax ¶85,110. (Staff Editor Parker Tax Publishing)

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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