T.C. Summary Opinion 2001-157
UNITED STATES TAX COURT
KARL MEYER AND VICKIE MEYER, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 7403-00S. Filed September 26, 2001.
Karl Meyer and Vickie Meyer, pro sese.
R. Scott Shieldes, for respondent.
ARMEN, Special Trial Judge: This case was heard pursuant to
the provisions of section 7463 of the Internal Revenue Code in
effect at the time that the petition was filed.1 The decision to
be entered is not reviewable by any other court, and this opinion
should not be cited as authority.
1
Unless otherwise indicated, all subsequent section
references are to the Internal Revenue Code in effect for 1997,
the taxable year in issue, and all Rule references are to the Tax
Court Rules of Practice and Procedure.
- 2 -
Respondent determined a deficiency in petitioners’ Federal
income tax for the taxable year 1997 in the amount of $3,612.
After a concession by respondent,2 the sole issue for
decision is whether petitioners engaged in an Amway activity for
profit within the meaning of section 183.
Background3
Some of the facts have been stipulated, and they are so
found.
Petitioners are husband and wife and have been married since
1992. They resided in Houston, Texas, at the time that their
petition was filed with the Court.
A. Petitioner Husband
Petitioner husband (Mr. Meyer) is, by profession, a salesman
of medical equipment and has been employed by Xomed, Inc. (Xomed)
for approximately 15 years. Xomed specializes in the production
of medical equipment for use by health care providers who
practice in the ear, nose, and throat area. As a salesman for
Xomed, Mr. Meyer typically contacts doctors and nurses within an
2
At trial, respondent conceded that petitioners are
entitled to the Schedule A, Itemized Deductions, deduction for
unreimbursed employee business expenses (incurred by petitioner
Karl Meyer in the course of his employment as a salesman for
Xomed, Inc.) as claimed by petitioners on their return for the
year in issue.
3
At trial, we deferred ruling on respondent’s relevancy
objection to petitioners’ Exhibit 23-P, a collection of business
articles. We now overrule that objection and admit the exhibit
into evidence.
- 3 -
assigned geographical territory in Texas for the purpose of
demonstrating and selling Xomed’s products.
Mr. Meyer is compensated by Xomed on a straight commission
basis, and he is precluded by his employer from participating in
other for-profit sales activities. His compensation for 1994
through 1999 was $80,114, $83,403, $116,186, $97,329, $140,008,
and $149,610, respectively.
B. Petitioner Wife
Petitioner wife (Mrs. Meyer) is a homemaker and mother of
three children: Alexandra, born in July 1989; Jeffrey, born in
August 1993; and Andrea, born in March 1995.
In 1985, Mrs. Meyer filed an assumed name certificate with
the Harris County (Houston, Texas) Clerk’s Office, adopting the
business name of Vickie Zozaya Enterprises. However, Mrs. Meyer
never conducted any type of activity with respect to this
enterprise.
In 1994, Mrs. Meyer began designing and making jewelry pins
and selling them at craft shows under the assumed name of
Trinkets, Etc. Less than a year thereafter, Mrs. Meyer ceased to
operate Trinkets, Etc. because its time-consuming nature and lack
of profitability did not allow Mrs. Meyer to properly care for
her children. Petitioners’ income tax return for 1994 included a
Schedule C, Profit or Loss from Business, claiming a net loss of
$188 (i.e, gross income of $247 less car expenses of $435) from
- 4 -
Trinkets, Etc.
C. Amway
In August 1994, petitioners began to operate an Amway
distributorship under the name of Meyer Enterprises. Petitioners
began the Amway activity after being recruited as “downline”
distributors by an “upline” distributor.
Amway is a supplier of household and personal use products
that are sold by individuals (distributors) through direct
marketing. An Amway distributor purchases Amway products for
resale to both customers and “downline” distributors, as well as
for personal use.
At least in theory, Amway distributors generate receipts by
selling Amway products directly to customers and by recruiting
new distributors. The new recruits become “downline”
distributors of the sponsoring distributor and a part of his or
her organization.4 In turn, each “downline” distributor is
encouraged to sponsor additional new distributors, all of whom
become a part of the initial distributor’s organization.5 Amway
does not assign exclusive geographical territories to any
distributor, nor does Amway impose a minimum sales quota on any
distributor.
4
The sponsoring distributor is referred to as the “upline”
distributor.
5
The process of recruiting new distributors is often
referred to as “building the legs” of a distributor's network.
- 5 -
Amway maintains a “pyramid” incentive system. Under this
system, an “upline” distributor receives a bonus based on the
volume of sales generated by his or her “downline” distributors.6
Thus, the system presumes that the “upline” distributor’s
potential for profit will increase as his or her network of
“downline” distributors becomes wider and deeper.7
Because the “upline” distributor’s bonus is based on the
volume of sales generated by “downline” distributors, such bonus
is not directly affected by a “downline” distributor’s
profitability or lack of profitability.
The Amway “pyramid” incentive system is promoted by Amway in
the form of the “9-4-2 plan”.8 Under the “9-4-2 plan”, each
Amway distributor is encouraged to personally recruit 9
“downline” distributors, each of whom in turn is encouraged to
recruit at least 4 “downline” distributors, each of whom in turn
is encouraged to recruit at least 2 “downline” distributors (for
6
The “upline” distributor’s bonus is also based on the
volume of sales generated by the “upline” distributor himself or
herself. However, the volume of such sales is generally minimal,
and the portion of the bonus attributable to such sales is
negligible.
7
The “width” of a network refers to the number of
“downline” distributors that are personally sponsored by the
distributor in question, and “length” refers to the number of
“downline” distributors that make up each “leg” of the network.
8
More typically, the Amway system is promoted in the form
of the “6-4-2 plan”. See Nissley v. Commissioner, T.C. Memo.
2000-178. The two plans are identical, except for the number of
first-tier “downline” distributors.
- 6 -
a total of 117 “downline” distributors in the initial
distributor’s organization). The “9-4-2 plan” is promoted as the
theoretical break-even point for a distributorship, assuming that
(1) the distributor and each “downline” distributor within the
distributor’s organization purchases $200 of Amway products per
month and that (2) the distributor does not have expenses
exceeding $2,000 per month. At least in theory, the potential
for profit is enhanced as each of the 117 “downline” distributors
in the distributor’s network successfully implements the “9-4-2
plan”.
The Amway “9-4-2 plan” does not provide meaningful guidance
to distributors regarding how expenses incurred in pursuing an
Amway activity may be reduced.
The structure of the Amway “pyramid” incentive system
effectively serves to discourage distributors from spending their
time personally trying to sell Amway products. In contrast, the
system effectively serves to encourage distributors to spend
their time trying to recruit an ever-increasing number of
“downline” distributors.
Amway distributors are entitled to purchase Amway products
for their personal use at distributor’s cost without the
customary percentage markup.9
9
Although the record is not crystal clear, it would appear
that 30 percent was the customary markup.
- 7 -
D. Nature of Petitioners’ Amway Activity
At the time that they were recruited as Amway distributors
in August 1994, petitioners had no prior experience with Amway or
an Amway type activity.
Other than accepting the Amway “9-4-2 plan”, petitioners
never developed a business plan for their Amway activity, nor did
they ever prepare profit projections or undertake any type of
market analysis. Although petitioners maintained a monthly
report of expenses incurred in pursing their activity, they never
prepared a break-even analysis nor a formal budget.
Despite their lack of experience with either Amway or an
Amway type activity, petitioners never sought meaningful counsel
from disinterested third parties. Rather, petitioners relied
principally on advice from “upline” distributors and other
interested Amway individuals.
Petitioners spent little time personally trying to sell
Amway products. Indeed, from February through September 1997, no
retail sales were made. Rather, petitioners concentrated on
trying to recruit, and retain, “downline” distributors. Gross
income received by petitioners consisted principally of bonuses
earned from the sale, or personal consumption, of Amway products
by “downline” distributors.
- 8 -
E. Petitioners’ Separation and Its Effect on the Amway
Activity
Upon becoming Amway distributors in August 1994, petitioners
assigned themselves different roles. Because Mrs. Meyer had
virtually no time to spend operating a business outside the home
due to parental obligations, and because of Mr. Meyer’s
experience as a salesman, the task of operating the Amway
activity was initially assumed by Mr. Meyer. Indeed, on their
income tax returns, petitioners identified Mr. Meyer as
“proprietor” of the distributorship.
In contrast, Mrs. Meyer assumed responsibility for taking
care of the paperwork for the Amway activity. This
responsibility included inputting data related to income and
expenses onto Quicken, the personal finance software program.
Mrs. Meyer would then periodically compile a list of expenses for
the preceding month. In addition to such paperwork tasks, Mrs.
Meyer also “associated” with the wives of prospective and actual
“downline” distributors.
In or about 1996 petitioners experienced marital problems
that lead to their separation in October 1996 and the
commencement of an action for divorce that December. Mr. Meyer
disassociated himself from the Amway distributorship, and Mrs.
Meyer assumed her husband’s role. In particular, petitioners
filed a Business Status Change Form with Amway in October 1996,
which form served to remove Mr. Meyer’s name from the
- 9 -
distributorship and to place the distributorship in Mrs. Meyer’s
sole name.
In addition to the $1,500 in negotiated child support to
which she was entitled, Mrs. Meyer hoped to receive from the
Amway distributorship “enough money so that I could continue
staying home with my kids.” In this regard, Mrs. Meyer estimated
that monthly Amway income of $1,000 would be sufficient to
sustain herself and her children. In order to produce that
income, Mrs. Meyer estimated that 25 “downline” distributors were
required, each of whom needed to purchase $200 of Amway products
for their personal use each month. In so estimating, Mrs. Meyer
relied on a profitability worksheet that was included with the
“9-4-2" plan given to her by her “upline” distributor.
Mrs. Meyer devoted “very little” time to making retail
sales. Rather, she “was out for distributors”. In this regard,
Mrs. Meyer attempted to recruit “downline” distributors by
“talking to anybody and everybody I knew. Anybody that shops.”
In order to talk to anyone who shops, Mrs. Meyer would frequent
public areas, such as churches, malls, and parks, in order to
make contacts so that she could “distribute hope back into
people’s lives.”.
- 10 -
F. Petitioners’ Reconciliation and the Termination of the
Amway Activity
By November 1997, petitioners had reconciled, and the
divorce action was nonsuited. Subsequently, at some point in
1998, petitioners decided that they would no longer actively
pursue the Amway activity. Since that time, however, Mrs. Meyer
has continued to renew her status as an Amway distributor in
order to retain the right to purchase Amway products, such as
vitamins and cleaning products, for petitioners’ personal use at
discount prices.
G. Petitioners’ Schedule C Losses
For all relevant years, specifically including the taxable
years 1994 through 1998, petitioners filed joint Federal income
tax returns. Petitioners attached to each of those returns a
Schedule C, Income or Loss From Business, identifying “Karl L.
Meyer” as “proprietor” of “Meyer Enterprises” and describing the
principal business or service of such enterprise as
“Distribution”.
Petitioners have never reported a profit from the Amway
activity. Rather, petitioners have consistently claimed losses
from this activity and have used such losses to offset Mr.
Meyer’s compensation as a salesman.
The following schedule reflects the losses claimed by
petitioners from the Amway activity on Schedules C of their tax
returns for 1994 through 1998:
- 11 -
Year Net Loss
1994 $4,216
1995 12,805
1996 16,295
1997 11,251
1998 4,997
49,564
Since 1998 petitioners have not claimed any losses from the
Amway activity.
Petitioners determined the amounts of their losses from the
Amway activity on Schedules C of their tax returns for 1994
through 1998 as follows:
1994 1995 1996 1997 1998
Gross income1 $27 $1,037 $504 $407 $2,810
Less: expenses 4,243 13,842 16,799 11,658 7,807
Net loss 4,216 12,805 16,295 11,251 4,997
1
Gross income was essentially the bonuses earned from the
sale (or personal consumption) of Amway products by “downline”
distributors. Petitioners themselves sold relatively few Amway
products.
Petitioners deducted expenses for the Amway activity on
Schedule C of their tax returns for 1994 through 1998 as follows:
- 12 -
1994 1995 1996 1997 1998
Advertising --- $231 $392 $173 $292
Car expenses $1,912 5,472 5,560 6,888 2,621
Commissions/fees 120 382 33 --- ---
Legal/prof. services --- 560 --- --- ---
Office expense --- --- 577 78 133
Supplies 1,162 1,582 --- 1,352 1,684
Travel 605 200 2,574 616 ---
Meals/entertainment1 405 169 194 52 186
Utilities --- 761 836 608 348
Other expenses
Pubs 15 3,289 3,226 --- ---
Seminars/workshops --- 1,196 2,587 1,364 1,104
Rally tickets 24 --- --- --- ---
Cell phone --- --- 592 458 1,086
Dues --- --- --- 56 28
Postage --- --- 128 13 11
Voice way --- --- --- --- 314
______ _______ _______ _______ ______
Total expenses 4,243 13,842 16,699 11,658 7,807
1
Net after 50-percent reduction per sec. 274(n).
For the year in issue, petitioners deducted car expenses for
a Suburban SUV based on “business” use of 74.13 percent.
Petitioners determined this percentage based on the following
figures:
“Business” miles driven 21,867
Personal miles driven 7,633
Total miles driven 29,500
Discussion
Under section 183(a), if an activity is not engaged in for
profit, then no deduction attributable to the activity shall be
allowed except to the extent provided by section 183(b). In
pertinent part, section 183(b) allows deductions to the extent of
gross income derived from an activity that is not engaged in for
profit.
- 13 -
Section 183(c) defines an activity not engaged in for profit
as “any activity other than one with respect to which deductions
are allowable for the taxable year under section 162 or under
paragraph (1) or (2) of section 212.” Deductions are allowable
under section 162 or under section 212(1) or (2) if the taxpayer
is engaged in the activity with the “actual and honest objective
of making a profit.” Ronnen v. Commissioner, 90 T.C. 74, 91
(1988); Dreicer v. Commissioner, 78 T.C. 642, 645 (1982), affd.
without opinion 702 F.2d 1205 (D.C. Cir. 1983).
The existence of the requisite profit objective is a
question of fact that must be decided on the basis of the entire
record. Benz v. Commissioner, 63 T.C. 375, 382 (1974). In
resolving this factual question, greater weight is accorded
objective facts than a taxpayer's statement of intent. Westbrook
v. Commissioner, 68 F.3d 868, 875-876 (5th Cir. 1995), affg. T.C.
Memo. 1993-634; sec. 1.183-2(a), Income Tax Regs. For purposes
of deciding whether the taxpayer has the requisite profit
objective, profit means economic profit, independent of tax
savings. Surloff v. Commissioner, 81 T.C. 210, 233 (1983).
The regulations set forth a nonexhaustive list of factors
that may be considered in deciding whether a profit objective
exists. These factors are: (1) The manner in which the taxpayer
carries on the activity; (2) the expertise of the taxpayer or his
advisers; (3) the time and effort expended by the taxpayer in
- 14 -
carrying on the activity; (4) the expectation that the assets
used in the activity may appreciate in value; (5) the success of
the taxpayer in carrying on other 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) any elements indicating personal pleasure or recreation.
Sec. 1.183-2(b), Income Tax Regs.
No single factor, nor even the existence of a majority of
factors favoring or disfavoring the existence of a profit
objective, is controlling. Id.; Ogden v. Commissioner, T.C.
Memo. 1999-397, affd. per curiam 244 F.3d 970 (5th Cir. 2001).
Rather, the relevant facts and circumstances of the case are
determinative. Golanty v. Commissioner, 72 T.C. 411, 426 (1979),
affd. without published opinion 647 F.2d 170 (9th Cir. 1981).
Based on all of the facts and circumstances in the present
case, we hold that petitioners did not engage in the Amway
activity for profit within the meaning of section 183.
We shall not analyze in depth all nine of the factors
enumerated in the regulation but rather focus on some of the more
important ones that inform our decision.
First, the history of consistent and substantial losses
incurred by petitioners in the Amway activity is indicative of a
lack of profit objective. See Golanty v. Commissioner, supra at
- 15 -
427; sec. 1.183-2(b)(6), Income Tax Regs. A series of losses
during the initial stage of an activity is not necessarily an
indication that a taxpayer is not engaged in an activity for
profit. Sec. 1.183-2(b)(6), Income Tax Regs. However, if such
losses continue beyond the period in which it is customary for an
activity to become profitable, then the losses, if they are
unexplainable, may be indicative of a lack of a profit objective.
Id.
Since the inception of the Amway activity in 1994,
petitioners never earned a profit therefrom but rather incurred
losses for 5 consecutive years. Indeed, petitioners’ aggregate
losses for the 5-year period from 1994 through 1998 amounted to
$49,564, thus averaging approximately $10,000 per year.
Further, no significant trend is discernible in the history
of petitioners’ losses. For 1994, 1995, 1996, and 1997,
petitioners incurred losses of $4,216, $12,805, and $16,295, and
$11,251 respectively. It bears mention that petitioners became
Amway distributors in the latter part of 1994; thus, the loss for
that year is based solely on 4 months of operation. Further,
although it is true that petitioners’ loss decreased in 1998 to
$4,997, it is also true that 1998 was the last year in which
petitioners actively pursued the Amway activity.
Second, we are not convinced that petitioners conducted the
Amway activity in a businesslike manner. Sec. 1.183-2(b)(1),
- 16 -
Income Tax Regs. Although petitioners maintained computer-
generated records for the Amway activity (and may also have
utilized a separate bank account), such records appear to have
been maintained principally to satisfy substantiation
requirements imposed by the Internal Revenue Code and thus to
“guarantee” the deductibility of expenses. In contrast, such
records do not appear to have been used as analytic or diagnostic
tools in an effort to achieve profitability of the Amway
activity. As we have previously stated:
the keeping of books and records may represent nothing
more than a conscious attention to detail. In this
case, there has been no showing that books and records
were kept for the purpose of cutting expenses,
increasing profits, and evaluating the overall
performance of the operation. The petitioner reviewed
her records, but she has failed to show that she used
them to improve the operation of the enterprise.
[Golanty v. Commissioner, supra at 430.]
Moreover, petitioners did not maintain certain types of
records, nor did petitioners employ certain elementary business
practices that one would expect of individuals pursuing an
activity with a profit objective. See Nissley v. Commissioner,
T. C. Memo. 2000-178; Ogden v. Commissioner, supra; Theisen v.
Commissioner, T.C. Memo. 1997-539; Hart v. Commissioner, T.C.
Memo. 1995-55. Thus, although a monthly report of expenses was
maintained, neither profit projections, a break-even analysis,
nor a formal budget was ever prepared. Further, no market
analysis was ever undertaken, nor was any business plan (other
- 17 -
than the Amway “9-4-2 plan”) ever developed.
Furthermore, for the year in issue, no in-depth analysis was
ever performed in order to determine how many “downline”
distributors were needed to attain a break-even point. Although
Mrs. Meyer estimated that 25 distributors were required to attain
a “bare bones” standard of living, such estimate was not based on
a business plan or any independent analysis. Rather, Mrs. Meyer
was content to rely on the profitability worksheet given to her
by an “upline” distributor.
A third factor militating against petitioners’ claim of
profit objective is the fact that petitioners had no experience
with Amway or an Amway type of activity at the time that they
were recruited by an Amway distributor. See sec. 1.183-2(b)(2),
Income Tax Regs. Since that time, petitioners have principally
relied only on advice from “upline” distributors and other
interested Amway individuals.
Yet, under the Amway system, the “upline” distributor’s
bonus is not directly affected by the “downline” distributor’s
profitability or lack of profitability; rather, what is important
to the “upline” distributor is the “downline” distributor’s
volume of sales. Nevertheless, petitioners have steadfastly
refused to seek meaningful counsel from disinterested third
parties regarding means by which the Amway activity might be made
- 18 -
profitable.10 See Poast v. Commissioner, T.C. Memo. 1994-399
(“for the most part, petitioners’ advisers were not experts as
much as they were upliners with a financial stake in petitioners’
retail and downline sales”); Ogden v. Commissioner, T.C. Memo.
1999-397 (“Amway distributors may be biased when discussing Amway
because they have a natural desire to advance the organization
and/or obtain income from a downliner.”).
Petitioners’ refusal to seek meaningful counsel from
disinterested third parties is all the more telling given the
fact that the advice received from interested Amway individuals
did nothing to reverse petitioners’ history of uninterrupted and
substantial losses. Furthermore, the record suggests that the
“advice” petitioners received consisted of little more than
platitudes, generalities, and encouragement to “give it all
you’ve got”.
A fourth factor militating against petitioners’ claim is the
amount of time that petitioners devoted to the Amway activity.
See sec. 1.183-2(b)(3), Income Tax Regs. In this vein, Mrs.
Meyer repeatedly testified that the key to a successful Amway
“business” was not selling products, but rather establishing an
extensive network of “downline” distributors in order to “change
10
We do not regard general encouragement given by Mrs.
Meyer’s divorce lawyer to “stick with it” to constitute
meaningful business counsel. In any event, Mrs. Meyer admitted
that this individual never gave her advice concerning how the
Amway activity might be made profitable.
- 19 -
the way people shop”. However, for the year in issue, Mrs. Meyer
could not approximate how much time she spent on the Amway
activity, other than to state that “very little” time was devoted
to retail sales. Indeed, the record reflects that no sales were
made for a consecutive 8-month period. Mrs. Meyer’s time and
effort consisted of nothing more than engaging in the daily
activities of a homemaker and mother. Her testimony at trial
underscores this conclusion:
Q: Do you know how much time you spent a day or a
week during 1997 showing the plan?
* * * * * * *
A: Not much in the beginning because again, like I
said, I was out meeting people, getting to know someone to –
in order to show them the plan, * * * I went to a lot of
Bible studies. * * * I was attending Second Baptist Church,
and they had a lot of singles activities, and so I would go
to them.
I went to shopping in the mall. That’s places I could
take the kids. I would go to parks. I would go to –
basically I talked to people, and anywhere and any way that
I could get a name, something that I could find in common
with them to get back with them again later to try and
develop and build a friendship.
Fifth, section 1.183-2(b)(8), Income Tax Regs., provides
that “Substantial income from sources other than the activity
(particularly if the losses from the activity generate
substantial tax benefits) may indicate that the activity is not
engaged in for profit especially if there are personal or
recreational elements involved.” Golanty v. Commissioner, supra
at 428-429; see Ransom v. Commissioner, T.C. Memo. 1990-381.
- 20 -
In the present case, Mr. Meyer is a successful salesman.
His aggregate commission income for the 3-year period from 1994
to 1996 amounted to $279,703, or approximately $93,000 per year.
For 1997, the year in issue, Mr. Meyer’s commission income
exceeded $97,000. On joint returns for each of these 4 years,
petitioners claimed losses from their Amway activity, which
losses served to reduce Mr. Meyer’s compensation, thereby
decreasing petitioners’ taxable income and achieving substantial
tax savings.11
This Court has observed that “there are significant elements
of personal pleasure attached to the activities of an Amway
distributorship” and that an “Amway distributorship presents
taxpayers with opportunities to generate business deductions for
essentially personal expenditures.” Brennan v. Commissioner,
T.C. Memo. 1997-60; see also sec. 1.183-2(b)(9), Income Tax
Regs.; cf. sec. 1.183-2(b)(8), Income Tax Regs., regarding the
reference to “personal or recreational elements” quoted above.
Moreover, petitioners received a personal benefit from their
Amway activity through their ability to purchase Amway products
for their own personal use at distributor’s cost without the
customary percentage markup. At trial, petitioners candidly
11
Those savings also helped to finance car expenses.
Thus, for example, in 1997 petitioners deducted automobile
expenses on their Suburban SUV based on “business” use in excess
of 74 percent.
- 21 -
admitted that one of the major benefits of being Amway
distributors was the savings that they could realize on the
purchase of products for personal use. The fact that Mrs. Meyer
has continued to renew her Amway membership in order to purchase
merchandise at discount prices illustrates the personal dimension
of the Amway activity.
On this record, we find that petitioners did not have the
requisite objective in 1997 of making a profit in the Amway
activity. Accordingly, we hold that petitioners are not entitled
to deduct the loss from the Amway activity for that year.
Reviewed and adopted as the report of the Small Tax Case
Division.
In order to give effect to our disposition of the disputed
issue, as well as respondent’s concession, see supra note 2,
Decision will be entered
under Rule 155.