IMPORTANT: The new tax law effective starting 2018 eliminated the tuition write-off, with limited exceptions for self-employed MBAs. Any references below to the tuition write-off is applicable only to amending past year tax returns within the statute of limitations (2015-2017). Updated 1/11/2019.
Students in a full-time master’s of business administration (MBA) program may want to consider planning out their taxes. The opportunity, from a tax perspective, is to figure out if there are any tax strategies that will prove advantageous for the years when the student has lower than normal income.
Editor’s Note: The potential tax reform bill under consideration in Congress adds a bit of an unknown this year, but we have done our best to take the current proposals into account and have indicated as such. Keep a close eye on the tax bill and make sure to consult with a tax advisor before implementing any of the strategies outlined below.
Full-time MBA programs create a unique tax period for its students, as many end up in a low tax bracket for possibly the only time in their adult lives. A savvy MBA can take advantage of these gap years in income by implementing tax planning strategies prior to the end of the year.
This article will describe several of those strategies to consider. We’ve structured the article based on year in school, so there is a separate section for first year MBA students, second year students, and recent graduates from the class of 2017.
Before getting started, we wanted to note that many MBAs take advantage of IRS rules that allow eligible students to write-off their tuition expenses on their tax return as an unreimbursed business expense. This often results in much greater tax savings than the standard education credits. We cover tax savings strategies for both students who do and do not already utilize this deduction, but if you need more background on expensing your tuition, start by reading here.
First Year MBA Students
First year MBA students typically worked for the first half of the year before quitting to enroll in school for the second half of the year. So a student in this situation, although it will vary widely, may have earned about $50,000 of income while employed and has had possibly around $30,000 of tuition expenses.
For a student in this situation, consider the following strategies:
- Accelerating spring tuition payments into 2017: For those utilizing the MBA tuition deduction, you may want to pay any upcoming tuition expenses before the end of the year. There are two reasons for potentially doing so. One, since you likely have more wage income this year than you will next year (when you only have a summer internship), writing off additional tuition this year may result in higher tax savings. You need to be careful though that you do not subject yourself to AMT. A tax advisor can help with this. Second, both versions of the tax bill in Congress currently propose eliminating the MBA tuition deduction. The new law would go into effect starting Jan 1, 2018, so tuition paid in 2017 would still be deductible, benefiting those who prepay. We don’t yet know if the tax bill will pass in its current form, but this is definitely something impacted MBAs should be tracking.
- Converting some or all of a Traditional 401(k) or IRA account to a Roth: Transferring assets from a pre-tax Traditional 401(k) or IRA to a Roth IRA account actually results in additional taxable income this year. The trade-off, though, is that investments in a Roth account do not get taxed again, including when you withdraw the funds during retirement. Traditional retirement accounts have their distributions included as taxable income during retirement. If subject to a low tax rate today, which is particularly likely for those utilizing the MBA tuition deduction, recognizing income today to reduce taxable income in retirement is a very beneficial tax planning move. This strategy of course requires having other funds available to pay the added tax bill that comes with the conversion. And, the key to this strategy is determining the optimal amount of those funds to convert to a Roth account based on your specific marginal tax rates.
- Making a Roth IRA contribution: Along the same lines as the Roth conversion described above, contributing directly to a Roth IRA might also be a strategy worth considering. The Roth IRA is a great vehicle since funds grow tax-free and is available to be withdrawn in retirement again without incurring any taxes. Due to income limits ($118,00 if single and $186,000 if married filing jointly in 2017), direct contributions to a Roth IRA are often not an option once fully employed. This strategy can be difficult for cash-strapped MBAs, but it may even be worth considering taking additional loans to up to the maximum allowable contribution of $5,500, if you believe the invested tax-free funds will outperform the student loan interest rate over the long-term.
Second Year MBA Students
Second year MBA students might be in an even lower tax bracket than their first year counterparts. These students only earned about $20,000 of income during a summer internship, and have paid even more than that over a full year of tuition at around $60,000.
For a student in this situation, look into the following:
- Accelerating spring tuition payments into 2017: These students might also want to prepay their upcoming spring tuition payment if utilizing the MBA tuition deduction (read more here if unfamiliar). For a student with more tuition than income, it won’t impact this year’s tax refund, but will result in a net operating loss (NOL) carryforward that can be applied in the following year’s tax return to offset income. NOLs can be carry forwarded up for 20 years until used up against earned income, so long as the NOL was claimed in the original tax return rather than in an amended/corrected tax return. Worth mentioning once again is that both versions of the tax bill in Congress currently propose eliminating this deduction starting Jan 1, 2018. So prepaying tuition ensures it would still be deductible. These students also need to be careful about running into the AMT, as it might negate the deduction if subjected to it, so it’s worth reviewing with a tax advisor first.
- Converting some or all of a Traditional 401(k) or IRA account to a Roth: Similar to first year students, second year students also should consider transferring assets from a pre-tax Traditional 401(k) or IRA to a Roth IRA account. This results in additional taxable income this year, while subject to a low marginal tax bracket. Recognizing the income now, at a low rate, then allows the funds to grow tax-free in the Roth account and can be withdrawn tax-free in retirement. As previously mentioned, this strategy requires having available funds to make any additional tax payment required today. Key to this strategy is determining the optimal amount of the assets in the Traditional account to convert to Roth based on your marginal tax bracket.
- Recognizing capital gains: For similar reasons why the Roth conversion is effective, recognizing capital gains is one of our favorite tax strategies. The long term capital gains (LTCG) rate, shown below, is zero so long as net taxable income (less deductions such MBA tuition expenses) remains in the lowest bracket, which is up to $37,950 for singles and $75,900 for married couples. Let’s look at a quick example for a single MBA student who earned $20,000 during a summer internship. That student could recognize $17,950 capital gains completely tax-free. For every dollar of tuition being deducted, another dollar of capital gains can be recognized without incurring taxes. For students that have appreciated stock portfolios, the second year of a MBA program is an ideal time to sell some of those investments. Whether you have stocks that have done well over time or Bitcoin that has quintupled over night, taking the gains today can be smart tax planning, and the proceeds can even simply be reinvested to reset your cost basis if the cash isn’t needed for other things (like paying tuition). Of course, be very careful to make sure that the sales do not push you into the higher tax bracket, as all of a sudden the tax rate can go from 0% to 15% on capital gains.
|Single Income Bracket||Married Income Bracket||LTCG Tax Rate|
|$0 – 37,950||$0 – 75,900||0%|
|$37,950 – 418,400||$75,900 – 470,700||15%|
Class of 2017 Recent Graduates
Recent graduates are in a similar situation as first year students, with about half of a year’s salary of income and half of a year’s tuition. While their tuition payments are behind them, there are still a few strategies they might want to employ this year while their income is lower than it will be next year.
For graduates in this situation, we recommend looking into the following:
- Contributing to a Roth 401(k) or IRA: If your employer offers a Roth 401(k) option, that should be your best bet for this year. Making pre-tax contributions to a Traditional 401(k) is not likely as beneficial because those contributions are avoiding taxes today while your tax rate is low, only to have the withdrawals subject to taxes in retirement when your rate might be higher. If you’ve already been contributing to a Traditional 401(k), at least consider making a Roth IRA contribution up to the maximum of $5,500 assuming your income for this year is below the 2017 eligibility threshold of $118,00 if single and $186,000 if married filing jointly.
- Converting some or all of a Traditional 401(k) or IRA account to a Roth: Recent graduates may also want to consider transferring assets from a pre-tax Traditional 401(k) or IRA to a Roth IRA account. This results in additional taxable income this year, while subject to a low tax rate, and Roth accounts have tax-free distributions while in retirement. As previously mentioned, this strategy requires having available funds to make any additional tax payment required today. Key to this strategy is determining the optimal amount of the assets in the Traditional account to convert to Roth based on your marginal tax bracket.
- Recognizing capital gains: For similar reasons why the Roth conversion is effective, recognizing capital gains might also be an effective strategy. If in the zero long term capital gains rate tax bracket as a result of having tuition payments that come close to cancelling out all wage income (brackets shown in the second year student section), it could be an opportune time to sell investments that have appreciated greatly. Of course, be very careful to make sure that the sales do not push you into the higher tax bracket, as all of a sudden the tax rate can go from 0% to 15% on capital gains.
Before taking any action, you first have to consider your full financial situation and we highly recommend consulting a tax advisor. These strategies can get very complicated, especially when employing more than one in tandem. In particular, MBA students with a working spouse would need to take into account their combined incomes and everyone has to watch out for the AMT that is still in effect for 2017.
We hope this article draws attention to some beneficial tax planning strategies that can be employed while in business schools. For MBA students emptying their savings to pay tuition, these strategies can make a big difference for your future finances.
Get started on your tax planning by signing up with Visor for a free tax consultation call. If you haven’t taken advantage of the MBA tuition deduction, don’t forget you can amend past returns up to 3 years later to still capture the tax savings.
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