In the Taxpayer Relief Act of 1997, education was king. There were many provisions, most taking effect in 1998, which allowed for expanded deductions and credits for qualified education expenses. Over the next month, we'll be looking at many of these provisions in much greater detail. But to kick off our "education month" series of articles, we'll visit an old friend that has been with us for a number of years: the deduction for education expenses.

The rules work like this: A deduction is available if the education maintains or improves the skills related to your trade or business. Educational costs are also deductible if the education is required (by law or by your employer) to keep your current position or job.

On the other hand, educational costs are not deductible if the education is required to get into the field (as opposed to staying in the field) or qualifies you for a new trade or business.

For example, a lawyer can't deduct basic law school costs because they are required to enter the legal field. Once she becomes a lawyer, however, any courses she takes to keep current or learn new techniques are deductible.

The expenses of becoming a specialist within a field may or may not be deductible. Let's take a doctor. If the goal all along was to become a psychiatrist and the individual went straight through medical school, internship, and then into a psychiatric residency, all of the costs would be treated as required to enter the field and would not be deductible. But an internist who has already been practicing medicine for a period of time can deduct the costs of a psychiatric program he enters as improving skills within his profession. See how the line could be a little bit hazy? And it can get even more confusing.

Many taxpayers take law-related courses for help in their professions or businesses. Seminars and/or courses that you take within your profession on law-related issues are generally deductible since they improve your current skills. Conversely, law school courses leading to a degree (even if taken for the same "improvement" purpose) are generally not deductible because they lead to qualifying you for a new profession.

You can see how the "maintain and improve" standard may not be as cut and dried as you might hope. In many cases, some tax research may be needed to see if your unique situation would be deductible or not. And many times, if the situation is truly unique, or the money involved is substantial, the assistance of a qualified tax pro could be in your best interest.

But let's say that you meet the "maintain and improve" standard and determine that your education costs are deductible. You not only get the benefit of the direct education expenses, but you can also include the transportation costs involved in getting from work to the course location or vice versa. Transportation between home and the course location is deductible for education undertaken on a temporary or irregular basis. If the transportation is in the nature of a commute, it's not deductible. If you're away from home for deductible education, you can include the costs of travel, meals (at 50%), and lodging as well. But, and this is a very big "but," travel as the educational vehicle itself (e.g., a French teacher's trip to France) is not deductible.

In the case of an employee, education expenses that are deductible under the above tests may be claimed as an itemized deduction, but only to the extent the expenses, along with other miscellaneous itemized deductions, exceed 2% of the taxpayer's adjusted gross income (AGI). And in the case of taxpayers with high AGI, miscellaneous itemized deductions are subject to a further overall limit. So, while your education expenses may be deductible, because of how they must be reported on your tax return, you may find that you receive little or no actual tax benefit for those expenses. Before you undertake any deductible education, you might want to check your tax status to determine what positive tax impact these deductions may actually have.

What happens if you find that your education expenses are not deductible? Or you find that while the expenses are deductible, your tax issues are such that you receive very little (or no) tax benefit. Do you just hang your head, pay your taxes, and move on? Not necessarily. And that's where many of the education provisions in the 1997 Tax Act kick in.

Did you know that you may be able to claim a deduction for interest up to $1,000 that you paid for qualified student loans in 1998 -- without even having to itemize your deductions?

Did you know that you may qualify for a HOPE tax credit of up to $1,500 per year for the first two years of undergraduate education at an eligible education institution?

Did you know that you may qualify for a Lifetime Learning Credit of up to $1,000 per year for any post high school education at an eligible education institution?

Did you know that your employer may be able to pay for some of your education-related expenses? And those payments would not be deemed taxable income to you?

It is likely that you didn't know about these provisions. Which is why we'll be discussing them in greater detail in the weeks to come. And since all of these provisions are interrelated in some form or another, it will be important to identify the combination of deductions and credits that will allow you the greatest tax benefit.

If you don't itemize your deductions, you will generally want to claim the HOPE/Lifetime Learning credits. Many of you will have to decide whether to take an itemized deduction for your education expenses or to claim the HOPE/Lifetime Learning credits for those expenses. If you are not subject to the overall limit on itemized deductions, you may find that an itemized deduction for education expenses is more advantageous than the Lifetime Learning credit.

Why? Because itemized deductions reduce your taxable income, and therefore save taxes at your top tax rate. On the other hand, if the education expenses are not related to your current trade or business but are incurred to acquire new job skills, the education expenses would not be allowable as an itemized deduction. Those same expenses, however, may still qualify for the HOPE/Lifetime Learning credit.

Confusing? It sure can be, which is why we want to take the time to shed some light on these issues. In the meantime, if you want to read more about deductible education expenses, check out IRS Publication 508 at the IRS website.

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- 10/02/98

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