T.C. Summary Opinion 2001-173
UNITED STATES TAX COURT
BROADRICK R. MOORE AND DAWN J. INGRAM, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 5686-00S. Filed October 30, 2001.
Broadrick R. Moore and Dawn J. Ingram, pro se.
Ross W. Greenberg, for respondent.
PANUTHOS, Chief Special Trial Judge: This case was heard
pursuant to the provisions of section 7463 of the Internal
Revenue Code in effect at the time the petition was filed. The
decision to be entered is not reviewable by any other court, and
this opinion should not be cited as authority. Unless otherwise
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indicated, subsequent section references are to the Internal
Revenue Code in effect for the years in issue, and all Rule
references are to the Tax Court Rules of Practice and Procedure.
Respondent determined deficiencies in petitioners’ Federal
income taxes of $2,138 in 1996 and $2,250 in 1997. The issues
for decision are whether petitioners’ Amway activity was an
activity engaged in for profit under section 183, and, if so,
whether petitioners have substantiated the claimed deductions
related to the activity.
Background
Some of the facts have been stipulated and are so found.
The stipulation of facts and the attached exhibits are
incorporated herein by this reference.
Petitioners were married during the tax years 1996 and 1997.
Their children, Chelsea and Kendall, were born in 1991 and 1995,
respectively. Petitioner Broadrick Moore (hereinafter
petitioner) worked full time as a lineman for an electric
company, which required him to travel on occasion. He was often
on call 24 hours a day, 7 days a week. Petitioner Dawn Ingram
(hereinafter Ms. Ingram) worked full time as a receptionist in a
medical office during the years in issue. Petitioners resided in
Beverly Hills, Florida, at the time that they filed their
petition.
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Petitioners were recruited in 1994 as “downline”
distributors of Amway Corp. (Amway) consumer products by an
“upline” distributor, and they registered as Amway independent
business owners (IBO). The originating distributor is an
“upline” distributor in relation to his recruit, who is a
“downline” distributor. An upline distributor receives points or
commissions and, therefore, profits, based on a downline
distributor’s sale of the Amway products and on the downline
distributor’s success in developing his own downline distribution
network. Additionally, a distributor profits from the sale of
the Amway products to third-party clients. See Elliott v.
Commissioner, 90 T.C. 960 (1988), affd. without published opinion
899 F.2d 18 (9th Cir. 1990), for a general discussion of the
operation of an Amway activity.
Petitioners “counseled upline”, that is, they sought
direction and training from their upline distributors.
Petitioners purchased motivational tapes and a marketing plan
from Amway. In addition, they attended weekend training seminars
with educational groups that work in conjunction with Amway.
Because their only previous business experience had been
petitioner’s involvement in a partnership that bought and sold
real estate, petitioners hired a certified public accountant
(C.P.A.) in 1994. Upon the C.P.A.’s advice, petitioners
purchased a computer-based accounting program, Peachtree, which
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they used to prepare monthly and long-term expense and income
reports used for budgeting. With the exception of the advice
from their C.P.A., petitioners did not seek guidance from an
independent source.
Petitioners prepared a handwritten outline of their
statement of goals in their January 1995 calendar notes.
Petitioners’ goals included recruiting three downline
distributors every month who would, in turn, find three of their
own downline distributors. The goals also project and calculate
commissions to be received from the downline distributors and
customers. For example, the goals included as follows: “Increase
300PV Per Month” and “Find 10 Customers = 500 - 1000 PV”.
Petitioners maintained calendars for 1996 and 1997 with
their daily personal and Amway engagements. These calendars have
handwritten entries indicating cities, hotels, and other items
such as “STP” (show the plan--a marketing of their business
plan), but it is not always clear which entries are related to
the Amway activity. Petitioners maintained daily and monthly
logs of “Business Expenses”, charts of their miles traveled,
parking, tolls, fares, meals, lodging, and other expenses (e.g.,
tickets) from January 1996 through December 1997. In the
“Business Purpose - Where, Why, Who, etc.” column in these
charts, petitioners wrote various cities, words, and
abbreviations (e.g., “Ft. Lauderdale STP”, “Gainsville Seminar”,
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and “Tax Meeting”). Petitioners also produced an “Office
Expense” chart listing monthly totals for their office expenses
such as home mortgage, electricity, telephone, heat, property
taxes, termite treatment, child care, computer program, and
C.P.A. fees for 1996.
In 1997, petitioners had approximately 30 downline
distributors in their distribution chain. Petitioners realized
in 1996 that their activity was not as profitable as they had
hoped, and petitioners alleged that they changed their marketing
approach--that is, how they approached the activity and how they
contacted people. They ended their Amway activity sometime in
the year 2000.
Petitioners filed their 1996 and 1997 Federal income tax
returns as married filing jointly. They reported gross income
from wages in the amount of $66,966 in 1996 and $68,399 in 1997.
Petitioners reported income and claimed expenses on Schedules C,
Profit or Loss From Business, with respect to their Amway
activity as follows:
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1996 1997
Income
Gross receipts $555 $924
Cost of Goods sold 1,248 681
Gross income (loss) (693) 243
Expenses
Advertising 25 –--
Car & truck 4,398 6,918
Depreciation 1,732 1,074
Legal & professional services 435 395
Office expense 143 109
Repairs & maintenance 131 ---
Taxes & licenses --- 7
Travel 1,683 ---
Meals & entertainment 76 209
Other (unspecified) 3,681 6,437
Total expenses 12,304 15,149
Net income (loss) (12,997) (14,906)
The assets for which petitioners took a depreciation
deduction in 1996 are as follows: A “satellite”, a computer, a
computer upgrade, a computer hard drive, a telephone system,
software, a 1991 Ford, and a 1988 BMW. Petitioners did not
provide a list of the assets for which depreciation was claimed
in 1997.
Petitioners reported gross income (loss) and net losses for
the 5-year period during which they participated in the Amway
activity as follows:
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1995 1996 1997 1998 1999 Total
1
Gross income $250 ($693) $243 $1,266 $443 $1,509
(loss)
Net loss ($13,770) ($12,997) ($14,906) ($11,049) ($8,437) ($61,159)
Petitioners stipulated a gross loss in 1997 in
1
the amount of $248, but reported gross income in the
amount of $243 on their 1997 return. The discrepancy
has not been explained.
Respondent disallowed the claimed Schedule C expense
deductions relating to the Amway activity because the activity
was not engaged in for profit and because petitioners failed to
substantiate the claimed expenses. Petitioners assert that they
operated the Amway activity as a business with the intent to earn
a profit.
Discussion
Deductions are a matter of legislative grace. INDOPCO, Inc.
v. Commissioner, 503 U.S. 79, 84 (1992).1
Section 162 allows a deduction for all of the ordinary and
necessary expenses that are paid or incurred during the taxable
year in carrying on a trade or business. Sec. 162(a).
Alternatively, section 212 allows a deduction for all of the
ordinary and necessary expenses paid or incurred during the
1
The examination commenced after July 22, 1998;
accordingly, we considered the applicability of sec. 7491.
Petitioners did not assert, nor did they present evidence, that
they complied with the requirements of sec. 7491(a)(2)(A) and (B)
to substantiate items, maintain required records, and fully
cooperate with respondent’s reasonable requests. Accordingly,
the burden of proof remains with petitioners.
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taxable year in the production or collection of income. Sec.
212(1). Section 167 allows a depreciation deduction for property
used in a trade or business or held for the production of income
if the expenses were incurred with a legitimate for-profit
activity. Sec. 167(a); Hulter v. Commissioner, 91 T.C. 371, 392
(1988).
Under section 183(a), no deductions attributable to the
Amway activity are allowable unless the activity is engaged in
for profit, except as provided in section 183(b). Sec. 183(a);
Elliott v. Commissioner, 90 T.C. at 960; Dreicer v. Commissioner,
78 T.C. 642, 643 (1982), affd. without published opinion 702 F.2d
1205 (D.C. Cir. 1983). Petitioners must have entered into or
continued the Amway activity with the actual, honest, and bona
fide objective of making a profit. Filios v. Commissioner, 224
F.3d 16 (1st Cir. 2000), affg. T.C. Memo. 1999-92; Hulter v.
Commissioner, supra at 392-393; Beck v. Commissioner, 85 T.C.
557, 569 (1985); Dreicer v. Commissioner, supra at 645; sec.
1.183-2(a), Income Tax Regs.
An activity that is “not engaged in for profit” means any
activity other than one with respect to which deductions are
allowable for the taxable year under section 162 or section
212(1) or 212(2). Sec. 183(c); sec. 1.183-2(a), Income Tax Regs.
The following nonexclusive factors are relevant in
determining whether an activity is engaged in for profit: The
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manner in which the taxpayer carries on the activity; the
expertise of the taxpayer or his advisers; the time and effort
expended by the taxpayer in carrying on the activity; the
expectation that assets used in the activity may appreciate in
value; the success of the taxpayer in carrying on other similar
or dissimilar activities; the taxpayer’s history of income or
losses with respect to the activity; the amount of occasional
profits, if any, which are earned; the financial status of the
taxpayer; and elements of personal pleasure or recreation.
Sec. 1.183-2(b), Income Tax Regs. No single factor is
controlling. Golanty v. Commissioner, 72 T.C. 411, 426 (1979),
affd. without published opinion 647 F.2d 170 (9th Cir. 1981).
Whether a taxpayer’s activity has been engaged in for profit is
determined by taking into account all of the facts and
circumstances of the case. Sec. 1.183-2(a), Income Tax Regs.
Petitioners performed a number of functions which have the
superficial indicia of an activity operated for profit. For
example, petitioners testified that they prepared a business plan
with the assistance of their C.P.A., and the stated plan was to
build a network of downline distributors to generate business
volume and ultimately to receive “points” or commissions from
Amway. Petitioners produced a copy of their written goals
(different from their business plan), a one page handwritten
document. Petitioners also maintained and produced a log of
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“Business Expenses” incurred in 1996 and 1997, and a chart of
“Office Expense” from 1996. They maintained and produced monthly
calendars reflecting both Amway-related entries and personal
entries for both 1996 and 1997. Also, Ms. Ingram claimed that
they opened a bank account for their Amway activity.
Nevertheless, we conclude that petitioners’ overall approach
to their activity was not businesslike. See sec. 1.183-2(b)(1),
Income Tax Regs. The records that petitioners produced do not
reflect details concerning their Amway activity, such as products
sold, clients, or downline distributors. In addition, the goals
do not provide any indication of how petitioners planned to
achieve the points and commissions, or how to find the customers.
Despite being given ample opportunity to produce relevant
business records, petitioners failed to do so, and they failed to
offer an explanation for their absence. For example, petitioners
failed to produce a copy of their business plan and bank records.
Petitioners produced an “Office Expense” chart for 1996, but not
for 1997, and did not offer any supporting bills or proof of
payment of any of the expenses. Petitioners did not retain paper
copies of the quarterly, semiannual, and annual reports of income
and expenses that they purportedly kept. Petitioner explained
that when their computer upgrade crashed, they lost all reports.
We are skeptical that all data that went into the reports was
irretrievably lost. Petitioners’ inability to produce the
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underlying income and expense data, reports, and other business
records and their failure to reconstruct the income and expense
reports indicate a disregard of businesslike activity and profit.
Id.
Petitioners asserted that they changed the way they did
business (i.e., marketing) in 1996, but petitioners have offered
no factual support for this assertion. Continuing to operate
such an unprofitable activity, even after a change in strategy
that was unsuccessful, indicates a lack of profit objective.
Filios v. Commissioner, 224 F.3d at 24; sec. 1.183-2(b)(1),
Income Tax Regs.
Petitioner testified that “if products don’t move, profit
doesn’t move”; yet petitioners failed to provide any indication
of how they attempted to sell the Amway products. Petitioners
did not present any facts or business records concerning sales of
products to customers such as customer lists or distribution
order forms. Rather, petitioners’ goals list and testimony
indicate that they focused on establishing a downline chain of
distributors more than they focused on selling products.
Moreover, petitioners claimed that they had approximately 30
downline distributors, but they neither produced a list of these
downline distributors nor had any of them testify. We are not
convinced that petitioners focused on selling Amway products and
that they focused on earning a profit.
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Petitioners asserted that they went to the library and
researched Amway on their own, and that they reviewed various
Amway materials before beginning their participation in the Amway
activity. There is nothing in the record to support petitioners’
assertions. Moreover, the record does not reflect any indication
that the C.P.A. with whom they consulted had expertise in
marketing consumer products. We are not convinced that
petitioners conducted any meaningful independent research
concerning their Amway activity or that they sought to educate
themselves to overcome their lack of experience and expertise.
Sec. 1.183-2(b)(2), Income Tax Regs.
Petitioners each claimed to have spent approximately 10
hours a week pursuing Amway activities, though petitioner
occasionally spent additional time attending seminars on
weekends. Both petitioners held full-time jobs during the years
in issue. In addition, Ms. Ingram experienced health-related
problems during the years in issue that prevented her from
spending time in pursuit of the Amway activity. We conclude that
petitioners did not devote significant time to the Amway
activity. Elliott v. Commissioner, 90 T.C. at 972; sec. 1.183-
2(b)(3), Income Tax Regs.
Ms. Ingram testified that petitioners became involved in
Amway because they thought that it would be an asset that could
be sold, which would be valuable for estate planning.
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Petitioners produced only two items, two Amway bulletins, one
entitled “Bulletin No. 3 Distributorship Inheritance” and one
entitled “Bulletin No. 3A Trust”, in support of their position.
We find that the Amway activity was not an appreciable asset, and
we are also not convinced that petitioners believed that it was
such an asset. Sec. 1.183-2(b)(4), Income Tax Regs.
Petitioners’ gross income from the sale of Amway products
never exceeded their expenses. Petitioners reported total gross
income over a 5-year period of $1,509. The $61,159 of Schedule C
expenses claimed during the 5 years of their participation in the
activity virtually guaranteed that petitioners would not earn a
profit. Elliott v. Commissioner, supra at 972; sec. 1.183-
2(b)(6) and (7), Income Tax Regs. Petitioner’s partial
explanation for their losses, that their downline distributors
“weren’t very motivated” in selling the Amway products, fails to
explain adequately the reason for the continuing losses over a
period of years.
Considering the record in its entirety, we are satisfied
that petitioners did not have the actual, honest, and bona fide
objective of making a profit. It appears that they became Amway
distributors simply to deduct expenses for items of a personal
nature. The claimed Schedule C deductions relating to the Amway
activity are allowed only to the extent of the gross income
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derived from the activity.2 Sec. 183(b)(2); Elliott v.
Commissioner, supra at 973.
As the result of our holding above, it is unnecessary for us
to address substantiation issues under section 274.
Reviewed and adopted as the report of the Small Tax Case
Division.
To reflect the foregoing,
Decision will be entered
under Rule 155.
2
We are uncertain whether the notice of deficiency allowed
deductions to the extent of the reported gross income. In order
to take them into account we shall enter a decision under Rule
155.