T.C. Memo. 1997-539
UNITED STATES TAX COURT
KENNETH C. & BECKY J. THEISEN, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 9759-96. Filed December 8, 1997.
Rory Alan Boatright, for petitioner.
Franklin R. Hise, for respondent.
MEMORANDUM OPINION
PAJAK, Special Trial Judge: This case was heard pursuant to
section 7443A(b)(3) of the Code and Rules 180, 181, and 182. All
section references are to the Internal Revenue Code in effect for
the years in issue. All Rule references are to the Tax Court
Rules of Practice and Procedure.
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Respondent determined deficiencies in petitioners' Federal
income taxes as follows:
Year Deficiency
1992 $3,160
1993 4,240
In the notice of deficiency, respondent disallowed petitioners'
deductions for Schedule C expenses incurred in connection with
their Amway activity because they were not ordinary and necessary
expenses within the meaning of section 162. By answer,
respondent raised the issue that petitioners did not intend to
make a profit from their Schedule C activities for 1992 and 1993.
In the answer, respondent also requested the Court to find that
the deficiencies in tax for 1992 and 1993 were subject to the
accuracy-related penalties under section 6662. Respondent's
answer further asserted that petitioners were negligent and
intentionally disregarded the rules or regulations under the
Internal Revenue Code in filing their 1992 and 1993 Federal
income tax returns.
Respondent has conceded that petitioners did not have a
substantial understatement of income tax for 1992 and 1993 under
section 6662(d). As a result of the concession, the parties
limited the issue of penalties to those under section 6662(b)(1)
as follows:
Year Penalty
1992 $632
1993 848
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The issues remaining for decision are: (1) Whether
respondent proved that petitioners did not engage in their Amway
activity for profit within the meaning of section 183; (2) if
not, whether petitioners proved they are entitled to deduct
expenses in carrying out the Amway activity as ordinary and
necessary expenses under section 162; and (3) whether respondent
proved that petitioners are liable for the accuracy-related
penalties under section 6662(b)(1).
The facts as stipulated are so found. The stipulation of
facts and attached exhibits are incorporated herein by this
reference.
Petitioners resided in Austin, Texas, at the time they filed
their petition. For convenience and clarity, we have combined
the findings of fact and opinion.
Petitioner Kenneth C. Theisen (petitioner) was employed full
time by the Internal Revenue Service (Service) as a revenue agent
during the years in issue. He had been so employed for the past
10 years. He has a Bachelor of Science in Accounting and is a
Certified Public Accountant. During 1992 and 1993, petitioner
Becky J. Theisen was employed as a travel agent. Petitioners
were the parents of two children.
Petitioners had been Amway distributors in 1979 and 1980.
Petitioners again became Amway distributors in 1991, and were
distributors during 1992 and 1993, the years in issue, and at
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least up to the date of trial. During the years in issue,
petitioner claimed that he participated in the Amway activity on
an average of 15-20 hours per week. Mrs. Theisen claimed that
she participated in the Amway activity with her husband on an
average of 4 hours per week. She stated that her primary
function was doing the paperwork and visiting with wives of
prospective distributors of Amway products.
Amway is a supplier of various household products. It sells
these products via marketing through distributors, such as
petitioners. Distributors purchase the products for personal
use, as well as for resale to customers and downline distributors
(also known as "downliners"). Distributors are encouraged to
recruit others to become downline distributors. The Amway system
is based on a pyramid system whereby a distributor's direct and
indirect sales are rewarded with bonuses.
Petitioners filed joint Federal income tax returns for 1992
and 1993. On Schedules C of these returns, petitioners claimed
net losses in the amounts of $11,074 and $14,881, for 1992 and
1993, respectively, from Theisen Enterprises.
Theisen Enterprises is petitioners' sole proprietorship.
Petitioners claim that Theisen Enterprises is engaged in the
business of selling Amway products. On Schedule C of each
return, line B, "principal business code", petitioners listed
"3012", which number represents "Selling door to door, by
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telephone or party plan, or from mobile unit". On their Federal
income tax returns for the years in issue, petitioners did not
disclose that they or Theisen Enterprises were engaged in an
Amway activity. In fact, on both returns, line A of Schedule C,
"Principal business or profession, including product or service",
was left blank.
Deductions are a matter of legislative grace. New Colonial
Ice Co. v. Helvering, 292 U.S. 435, 440 (1934). Respondent's
determinations are presumed correct, and petitioners bear the
burden of proving otherwise. Rule 142(a); Welch v. Helvering,
290 U.S. 111, 115 (1933). However, respondent bears the burden
for any new matter pleaded in the answer. Rule 142(a).
Petitioner made a motion to that effect as to the section 183
issue, and the Court granted it. Respondent acknowledged the
burden of proof as to the section 6662(b)(1) issue for both
years.
Section 183(a) disallows any deductions attributable to
activities not engaged in for profit except as provided under
section 183(b). Taxpayers need not have a reasonable expectation
of profit. However, the facts and circumstances must demonstrate
that they entered into the activity, or continued the activity,
with the actual and honest objective of making a profit. Taube
v. Commissioner, 88 T.C. 464, 478 (1987); Dreicer v.
Commissioner, 78 T.C. 642, 645 (1982), affd. without opinion 702
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F.2d 1205 (D.C. Cir. 1983); sec. 1.183-2(a), Income Tax Regs.
The taxpayer's motive to make a profit must be analyzed by
looking at all the surrounding objective facts. Dreicer v.
Commissioner, supra at 645. These facts are given greater weight
than to petitioners' mere statement of intent. Dreicer v.
Commissioner, supra.
Section 1.183-2(b), Income Tax Regs., provides a
nonexclusive list of relevant factors to be considered in
deciding whether an activity is engaged in for profit. These
factors are: (1) The manner in which the taxpayer carries on the
activity; (2) the expertise of the taxpayer or his advisors; (3)
the time and effort expended by the taxpayer in carrying on the
activity; (4) the expectation that assets used in the activity
may appreciate in value; (5) the success of the taxpayer in
carrying on similar or dissimilar activities; (6) the taxpayer's
history of income or losses with respect to the activity; (7) the
amount of occasional profits, if any, which are earned; (8) the
financial status of the taxpayer; and (9) elements of personal
pleasure or recreation. Sec. 1.183-2(b), Income Tax Regs. These
factors are not applicable or appropriate in every case.
Abramson v. Commissioner, 86 T.C. 360, 371 (1986).
After a review of the record, we conclude that respondent
has carried the burden of proving that petitioners lacked the
requisite profit objective within the meaning of section 183 in
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operating their Amway activity. Petitioners' Amway activity
resulted in a net loss for taxable years 1992 and 1993. Although
it is not unusual for a business to incur losses in its early
years, we believe that petitioners never had any intention of
making a profit from this activity.
Petitioners contend that their Amway activity was motivated
by profit. Petitioners averred that they carried on their Amway
activity in a businesslike manner, maintained complete and
accurate financial records and books, studied the market and
strategies of others, attended seminars, and conformed their
sales techniques with more successful approaches. However, the
record indicates that petitioners did not operate in a
businesslike manner. Petitioners did not have a business plan,
nor did they conduct a break-even analysis. Petitioners had no
budget.
Petitioner candidly admitted in court that one of the major
benefits of being an Amway distributor was that such distributors
could purchase various products for personal use at a discount of
15 to 50 percent, if not more. He further stated that the
opportunity to purchase discounted products was a benefit. His
testimony evidenced that petitioners used their Amway
distributorship for their own personal financial gain. He
stressed this benefit when he made sales pitches in his attempts
to recruit potential downliners.
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When questioned whether his downliners sell the products,
petitioner testified:
Generally, no. The way the plan is written is, you're
taught to purchase things from yourself for yourself, and
you get other people -- say, Look. Just change your buying
habits. Don't go to HEB. Don't go to Eckerd's. Don't go
to Sam's. You get access to all these products. Change
your buying habits. Buy things for yourself.
Petitioner also conceded that petitioners' personal
purchases were more than the purchases they acquired for resale
to other customers or downline distributors. Specifically,
petitioner admitted that in 1992 he bought $4,500 of products for
personal use and $3,262 of products for other purposes. For
1993, he conceded he bought $10,729 of products for personal use
and $4,991 of products for other purposes.
Petitioners have consistently reported tax losses on their
Amway activity. Although only taxable years 1992 and 1993 are at
issue here, petitioners have claimed net losses from their Amway
activity for taxable years 1991 through 1995, of $2,745.06,
$11,073.51, $14,881, $13,008, and $11,681, respectively.
Petitioner could not explain with any detail or certainty
how or when the Amway activity would become profitable. He could
not explain how many downliners he needed to recruit in order to
realize a profit. Moreover, he stated that when downliners
purchased products through petitioners the purchases were at
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cost. Consequently, any opportunity for petitioners to make a
profit was limited to Amway bonuses.
Petitioners claimed car and truck expenses in excess of the
gross receipts reported on their 1992 and 1993 Schedules C. The
parties agreed that petitioners' 1992 vehicle expenses attributed
by petitioner on the returns to business use was 57 percent of
the total mileage. In 1993, petitioners purchased a new vehicle
and claimed 70 percent of its expenses as business expenses on
the return. Petitioners' 1992 ledger shows that 50 percent of
their telephone bill was attributed to business use, and the
other 50 percent was for personal use. In 1993, that ratio
increased to 80 percent business use and 20 percent personal use.
Petitioner could not explain why there were such substantial
increases in vehicle and telephone expenses without a concomitant
increase in revenue.
Petitioners contend that their detailed ledger of income and
expenses supports their position that their Amway activity was
motivated by profit. Although a detailed ledger of income and
expenses is relevant, it appears that petitioners maintained
these records for substantiation purposes rather than to monitor
the income and expenses of their Amway activity. As stated
repeatedly on the record, substantiation is not an issue in this
case.
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Petitioners' record-keeping is also not complete and
accurate. In light of his position as a revenue agent for the
Service, petitioner must have realized that the absence of gross
income would tend to indicate that the activity lacked any profit
motive. We believe that petitioner intentionally failed to
include the cost of motivational tapes in the calculation of
costs of goods sold in order to avoid disclosing a negative gross
income on the Schedule C for both years. Petitioner admitted
that if these purchases had been included in costs of goods sold,
petitioners would not have had any gross income for those years.
We agree with respondent that these purchases should have been
included in the costs of goods sold. Accordingly, we find that
petitioners did not have gross income in 1992 or 1993.
We have considered petitioners' other arguments and find
that they are without merit.
On this record, we find that petitioners did not have an
honest objective to make a profit in their Amway activity.
Petitioners operated this activity primarily because it allowed
them to purchase discounted merchandise for personal use, and it
enabled them to convert personal expenses to Schedule C
deductions. Section 262 disallows any deduction for personal,
living, or family expenses. Examination of their Schedules C for
both years shows that they were not entitled to claim any
deductions "otherwise allowable" pursuant to section 183(b)(1).
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Moreover, because there was no gross income in either 1992 or
1993, petitioners were not entitled to any deductions under
section 183(b)(2). In sum, petitioners were not entitled to any
deductions from their Amway activity for 1992 and 1993.
In view of our holding on the section 183 issue, we need not
address the section 162 issue.
Section 6662(a) provides for an accuracy-related penalty in
the amount of 20 percent of the portion of an underpayment of tax
attributable to, among other things, negligence or disregard of
rules or regulations. Sec. 6662(a) and (b)(1). Negligence is
defined to include any failure to make a reasonable attempt to
comply with the provisions of the Internal Revenue laws. Sec.
6662(c); sec. 1.6662-3(b)(1), Income Tax Regs. Moreover,
negligence is the failure to exercise due care or the failure to
do what a reasonable and prudent person would do under the
circumstances. Neely v. Commissioner, 85 T.C. 934, 947 (1985).
Disregard is defined to include any careless, reckless, or
intentional disregard of rules or regulations. Sec. 6662(c);
sec. 1.6662-3(b)(2), Income Tax Regs.
Respondent also has met the burden of proof on this issue.
Petitioner possesses an accounting degree, is a Certified Public
Accountant, and has been a revenue agent with the Service for the
past 10 years. Given his experience and extensive background in
tax-related matters, it is apparent that petitioner failed to
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exercise due care and disregarded the Internal Revenue laws when
he claimed personal expenses as business deductions. Therefore,
we find petitioners liable for the penalties under section
6662(b)(1) for 1992 and 1993.
To reflect the foregoing,
Decision will be entered
for respondent.