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Physician's Tuition Repayment Was a Nondeductible Personal Expense.
(Parker Tax Publishing February 2014)

A physician could not deduct medical school tuition he had to repay because the circumstances under which he received the original payment were of a personal nature. Dargie v. U.S., 2014 PTC 69 (6th Cir. 2/5/14).

In 1993, Tripp Dargie enrolled as a student at the University of Tennessee College of Medicine (UT). In 1994, he entered into an agreement with UT and Middle Tennessee Medical Center (MTMC) that provided that MTMC would pay his tuition, fees, and other reasonable expenses for attending UT. After graduation and the completion of his residency, Dr. Dargie was required to repay MTMC's grant by either (1) working as a doctor in the medically underserved community of Murfreesboro, Tennessee, for four years or (2) repaying two times the uncredited amount of all conditional award payments he received or a lesser amount agreed to by UT. During his time in medical school, MTMC paid UT $73,000 on Dr. Dargie's behalf as part of the agreement.

After completing his medical training in 2001, Dr. Dargie decided not to work as a doctor in Murfreesboro. Instead, he chose to practice in Germantown, Tennessee, near Memphis. In 2002, for not fulfilling his service obligation, Dr. Dargie repaid $121,440 a sum equal to the $73,000 principal he had received plus interest.

In 2005, Dr. Dargie and his wife filed an amended tax return for 2002, claiming they had inadvertently omitted an ordinary and necessary business expense on their Schedule C for the full amount of the $121,440 repayment. The Dargies sought to recover a recalculated refund of $30,304 plus interest. The IRS disallowed the deduction and the Dargies initiated a refund suit claiming the IRS had erred in its decision.

A district court found for the IRS, concluding that Dr. Dargie's repayment of the funds was a personal expense, and no deduction was allowed under Code Sec. 265(a)(1) because the repaid amount was allocable to income the Dargies had received tax free. The Dargies appealed.

Before the Sixth Circuit, the Dargies argued that the $121,440 amount sent UT in 2002 was a damages payment for Dr. Dargie's breaching the agreement with MTMC to work in Murfreesboro after his medical training. Consequently, he argued that the payment was an ordinary and necessary business expense permitted under Code Sec. 162(a) because it enabled him to pursue his for-profit medical practice in a different area of the state. The IRS countered that the payment to UT did not qualify as a deduction because educational expenses that allow an individual to meet the minimum requirements for practicing a given profession are personal.

The Sixth Circuit affirmed the district court's decision and held that the repayment by Dr. Dargie was not deductible. The court noted that, to determine whether an expense is a nondeductible personal expense or a deductible business expense, courts look to the origin and character of the claim with respect to which an expense was incurred, rather than its potential consequences upon the fortunes of the taxpayer. Thus, the court stated, the circumstances under which Dr. Dargie received the money determine its business or personal characterization, not the circumstances under which he repaid it. Dr. Dargie, the court observed, did not dispute that MTMC paid for his medical education and that education enabled him to meet the prerequisites for working as a physician. Moreover, Reg. Sec. 1.162-5(b)(2) specifically categorizes as nondeductible expenditures made by an individual for education that is required of him in order to meet the minimum educational requirements for qualification in his employment or other trade or business.

For a discussion of the deductibility of work-related educational expenses, see Parker Tax ΒΆ85,110. (Staff Contributor Parker Tax Publishing)

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