Was doctor’s deduction business or education?

A medical doctor could not deduct as a business expense a payment he made to a medical facility that had paid his tuition under an agreement he entered into years earlier, the Sixth Circuit Court of Appeals held recently, affirming a federal district court’s decision.

The doctor was obligated to make the payment after he failed to work in a specified community for the full period set forth in the agreement (Tripp and Holley Dargie v. United States, CA-6, 113 AFTR 2d Paragraph 2014-457, Feb. 5, 2014).

In 1993, Tripp Dargie enrolled as a student at the University of Tennessee College of Medicine (UT). In 1994, he entered into a Conditional Award Agreement with UT and Middle Tennessee Medical Center that provided that the medical center 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 the medical center’s grant in one of the following ways:

  • By working as a doctor for four years in the medically underserved community of Murfreesboro, Tenn.
  • By repaying the $73,000 paid to UT by the medical center on his behalf, plus interest

After completing his medical training in 2001, Dargie decided not to work as a doctor in Murfreesboro. Instead, he chose to practice near Memphis. In 2002, Dargie repaid $121,440, consisting of the $73,000 he had received, plus interest.

In 2005, Dargie filed an amended return for 2002, claiming that he had inadvertently failed to claim a business expense deduction for the $121,440. The IRS disallowed the deduction, and Dargie went to district court, which held that the repayment was a nondeductible personal expense.

In the appeal, Dargie argued that the $121,440 was a “damages payment” for breaching the agreement with the medical center. He asserted that the payment was an ordinary and necessary business expense because it enabled him to pursue his for-profit medical practice in a different area of the state.

The IRS countered that the payment was in the nature of an educational expense that allowed Dargie to meet the minimum requirements for practicing as a physician. Therefore, the expense was nondeductible.

To determine whether the expense was a nondeductible personal expense or a deductible business expense, the appeals court decided to look to the origin and character of the claim under which the expense was incurred, rather than its potential consequences upon the fortunes of the taxpayer. In essence, the circumstances under which Dargie received the money determined its business or personal characterization, not the circumstances under which he repaid it.

Since Dr. Dargie received the money to pursue his basic medical education, the repayment was nondeductible.