T.C. Summary Opinion 2002-147
UNITED STATES TAX COURT
LARRY MINNICK AND CHARLA MINNICK, Petitioners v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 8427-00S. Filed November 18, 2002.
Marshall H. Barkin, for petitioners.
Brandi B. Darwin, for respondent.
DINAN, 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 indicated,
subsequent section references are to the Internal Revenue Code in
effect for the years in issue.
- 2 -
Respondent determined deficiencies in petitioners’ Federal
income taxes of $5,387 and $3,774 for the taxable years 1996 and
1997.
The issue for decision is whether petitioners’ Amway
activity in 1996 and 1997 was operated for profit such that
petitioners may deduct expenses related to that activity in
amounts greater than those allowed in the notice of deficiency.1
Some of the facts have been stipulated and are so found.
The stipulations of fact and the attached exhibits are
incorporated herein by this reference. Petitioners resided in
Palatka, Florida, on the date the petition was filed in this
case.
From 1992 through 1998, petitioner husband worked 45 hours
per week as a maintenance supervisor for Georgia Pacific
Corporation, while petitioner wife worked as a teaching
assistant. Petitioners both have been involved with an Amway
distributorship since 1989, operating it under the name Minnick
Enterprises.2 Amway, a supplier of various products for personal
1
The adjustment in the notice of deficiency to the 1996
medical expense deduction is computational and will be resolved
by the Court’s holding on the issue in this case.
2
Petitioner husband stated at trial that petitioners are now
“Quixtar distributors” rather than Amway distributors. Although
the exact nature of the relationship between Amway and Quixtar
remains unclear, Quixtar apparently is a new computerized sales
system which is related to Amway but which is used for both Amway
and nonAmway products. Because petitioners appear to have been
(continued...)
- 3 -
use, uses a direct marketing approach to promote sales of its
products. It is based on an incentive system whereby a
distributor’s sales are rewarded by bonus checks. In addition to
earning commissions on their retail sales to consumers,
distributors can increase their proceeds through the sale of
products by individuals whom the distributor recruits. The
former are known as “upliners” or “sponsors”, while the latter
are known as “downliners”. Upliners sell Amway products to
downliners at the same prices at which the upliners purchased
them, and then earn bonuses based on the volume of the sales.
Thus, the wider the network of downliners a distributor creates,
the greater is the distributor’s profit potential.
Petitioners did not have written contracts with their
sponsors or any of their downliners. Prior to becoming
distributors for Amway, petitioners did not review the financial
records of any other Amway distributor regarding that
distributor’s success with Amway, nor did they have a written
business plan detailing how they intended to profit from their
distributorship. Petitioners, however, did speak with existing
Amway distributors concerning the nature of Amway operations.
Petitioners received reports from their upliner and from
2
(...continued)
primarily involved in the purchase and promotion of Amway
products, we will continue to refer to their activity as an Amway
distributorship.
- 4 -
Amway regarding their downliners. These reports summarized order
activity and bonus information. Petitioners maintained a
contemporaneous diary of meeting activities, but they did not
maintain periodic financial statements for the distributorship.
During 1996, petitioners constructed a building on their
residential property, a “pole barn”, which for a short period of
time was used in part for storage of Amway products. However, at
some point during the years in issue, petitioners no longer
needed to store products, and the building subsequently was used
for entirely unrelated purposes. On average, petitioners devoted
approximately 2 nights per week, and approximately 2 weekends per
month, to the Amway activity. Petitioners’ taxable wage and
salary income was as follows for each respective year:
1992 1993 1994 1995 1996 1997
$61,137 $65,980 $64,018 $65,500 $67,000 $72,403
Petitioners reported the following Amway-related gross
income and net losses on their joint Federal income tax returns
for taxable years 1992 through 1997:
1992 1993 1994 1995 1996 1997
Gross income $18,768 $11,968 $2,972 $2,888 $3,500 $10,431
Net loss (9,559) (25,724) (18,056) (18,392) (19,395)
(12,349)
In the notice of deficiency, which relates only to taxable years
1996 and 1997, respondent determined that the income petitioners
received from their Amway activity was not earned in connection
with an activity conducted for profit. Thus, respondent
determined that petitioners were required to report the Amway-
- 5 -
related income as “other income” on the front of petitioners’
Forms 1040, U.S. Individual Income Tax Return, rather than as
business income on the Schedules C, Profit or Loss From Business.
Respondent accordingly disallowed the related Schedule C expenses
which were in excess of the Amway income, and recharacterized the
remaining related expenses as miscellaneous itemized deductions
subject to the 2-percent floor under section 67(a).3 Petitioners
argue that the Amway activity was engaged in for profit and that
the related expenses should therefore be allowed in full as
deductions.
In order for expenses incurred in connection with an
activity to be deductible, the expenses generally must have been
ordinary and necessary either in carrying on a trade or business
or in an activity engaged in to produce income. Secs. 162(a),
212; Elliott v. Commissioner, 90 T.C. 960, 969 (1988), affd. 899
F.2d 18 (9th Cir. 1990). In order for the expenses to be
deductible in either situation, taxpayers must have conducted the
activity with the intent to make a profit. Elliott v.
Commissioner, supra at 970. Alternatively, taxpayers may claim a
deduction under section 183(b)(2) to the extent of the income
derived from the activity, if they otherwise meet the
3
Respondent also determined that, if petitioners were found
to have had a profit objective, a portion of the claimed Amway-
related expenses was nevertheless not deductible under sec. 162.
Based on our holding, we need not address this alternative
position.
- 6 -
requirements of that section.
The test to determine whether a taxpayer conducted an
activity for profit is whether he or she engaged in the activity
with an actual and honest objective of earning a profit. Keanini
v. Commissioner, 94 T.C. 41, 46 (1990); Dreicer v. Commissioner,
78 T.C. 642, 644-645 (1982), affd. without published opinion 702
F.2d 1205 (D.C. Cir. 1983); sec. 1.183-2(a), Income Tax Regs.
Although a reasonable expectation of profit is not required, the
taxpayer’s profit objective must be bona fide, as determined from
a consideration of all the facts and circumstances. Keanini v.
Commissioner, supra; Dreicer v. Commissioner, supra at 645;
Golanty v. Commissioner, 72 T.C. 411, 425-426 (1979), affd.
without published opinion 647 F.2d 170 (9th Cir. 1981); Bessenyey
v. Commissioner, 45 T.C. 261, 274 (1965), affd. 379 F.2d 252 (2d
Cir. 1967). More weight is given to objective facts than to the
taxpayer’s statement of his or her intent. Engdahl v.
Commissioner, 72 T.C. 659, 666 (1979); sec. 1.183-2(a), Income
Tax Regs.
The regulations under section 183 provide nine nonexclusive
factors to be used in determining whether a taxpayer is
conducting an activity with the intent to make a profit. Sec.
1.183-2(b), Income Tax Regs. The factors are: (1) The manner in
which the taxpayer carried on the activity; (2) the expertise of
the taxpayer or his or her advisers; (3) the time and effort
- 7 -
expended by the taxpayer in 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 loss 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. Id. No single factor controls, other factors may be
considered, and the mere fact that the number of factors
indicating the lack of a profit objective exceeds the number
indicating the presence of a profit objective (or vice versa) is
not conclusive. Id.
Application of the Factors
1. Manner in Which the Taxpayer Carries On the Activity
A profit objective may be indicated where the taxpayer
operates the activity in a businesslike manner and keeps complete
and accurate books and records. Sec. 1.183-2(b)(1), Income Tax
Regs. Petitioners’ Amway activities were not conducted in a
sufficiently businesslike manner. Petitioners did not maintain
their own business records other than notes of meetings in a
daily planner. Petitioners did not present evidence of any
formal budgets, profit projections, or break-even analyses which
had been prepared in connection with their distributorship.
Although certain reports were provided to petitioners by Amway
- 8 -
and by their upliners, these were merely summary reports and show
no independent effort by petitioners to track and/or improve upon
the financial progress of the distributorship. Furthermore,
petitioners did not make any substantial alterations in an
attempt to improve the manner in which they conducted their
operations, even after six or more years of losses. We find that
this factor favors respondent.
2. The Expertise of the Taxpayer or his Advisers
A profit objective may be indicated where the taxpayer
carries on an activity in accordance with practices learned from
extensive study of accepted business and economic practices, or
consultation with experts involved therein. Sec. 1.183-2(b)(2),
Income Tax Regs. Petitioners sought the advice of persons who
might be considered experts in Amway-related activities.
Petitioners attended various events conducted regularly which
they believed would provide the expertise necessary to make their
distributorship profitable. Although no evidence shows that
petitioners sought the advice of experts outside the Amway
organization, who might have had a more objective viewpoint
regarding business plans and strategies, we find that this factor
favors petitioners.
3. Time and Effort Expended by the Taxpayer
A profit objective may be indicated where the taxpayer uses
much of his personal time and effort to carry on the activity.
- 9 -
Sec. 1.183-2(b)(3), Income Tax Regs. Petitioners devoted
approximately two nights per week, and approximately two weekends
per month, to the Amway activity. This time was spent in
delivering products and in traveling to other individuals’ homes
for evening meetings as well as to monthly meetings and quarterly
“major functions”. In addition, petitioners concentrated on
recruiting downliners, from whom income could be derived
independently from the direct efforts of petitioners, rather than
making direct sales. We find that this factor favors
petitioners.
4. Expectation That Assets Used in the Activity Would
Appreciate in Value
Despite a lack of profit from current operations, a profit
objective may be indicated where a taxpayer intends to earn an
overall profit with income earned from operations together with
the appreciation in the value of assets used in the activity.
Sec. 1.183-2(b)(4), Income Tax Regs. The pole barn constructed
on petitioners’ property was used temporarily in part for Amway-
related purposes. However, this structure was used for Amway
activities only temporarily, and there is no indication that
petitioners intended to realize significant appreciation from it.
We find that this factor remains neutral.
5. Taxpayer’s Success in Other Activities
A profit objective may be indicated where the taxpayer has
in the past taken similar activities and made them profitable
- 10 -
despite initial unprofitability. Sec. 1.183-2(b)(5), Income Tax
Regs. No evidence was produced showing that either of
petitioners had ever engaged in activities similar to Amway, or
that either had ever been involved with making other activities
profitable. We find that this factor favors respondent.
6. & 7. Taxpayer’s History of Income or Losses and the
Amount of Occasional Profit, If Any
A profit objective is strongly indicated where the taxpayer
has experienced a series of profitable years. Sec. 1.183-
2(b)(6), Income Tax Regs. A series of losses incurred during the
startup stage of an activity does not necessarily indicate the
lack of a profit objective, but it may so indicate if the losses
continue beyond the customary startup period and are not
otherwise explainable as due to customary business risks. Id.
Petitioners sustained substantial losses in their distributorship
activities for at least six consecutive years,4 no profits were
ever earned from the activity, and there is no indication that
Amway distributorships which may eventually become profitable
sustain such substantial and prolonged losses. Furthermore,
petitioner husband’s testimony indicates that the income earned
from the distributorship was directly related to certain major
expenses, implying a correlation between income levels and
expense levels which would in effect always preclude the
4
The profits and/or losses from the activity in the years
1989 through 1991 and after 1997 are not in the record.
- 11 -
realization of a profit. We find that these factors favor
respondent.
8. Financial Status of the Taxpayer
A profit objective may be indicated where the taxpayer does
not have substantial income from sources other than the activity.
Sec. 1.183-2(b)(8), Income Tax Regs. Petitioners’ separate wage
and salary income provided a substantial source of income apart
from the distributorship: Petitioners’ taxable income from their
employment for 1996 and 1997 was in the amount of $67,000 and
$72,403, respectively. We find that this factor favors
respondent.
9. Elements of Personal Pleasure or Recreation
A lack of profit objective may be indicated where there are
personal motives for carrying on the activity, especially where
the motive is personal pleasure or recreation. Sec. 1.183-
2(b)(9), Income Tax Regs. Profit need not be the only objective,
however, and personal motives may coexist with an actual and
honest intent to derive a profit. Id.
The significance of personal motives in this case is
difficult to gauge. On the one hand, petitioners expended a
substantial amount of time in activities, such as driving long
distances, which would appear to lack elements of pleasure or
recreation. On the other hand, much of petitioners’ activities
involved elements which were very personal in nature, such as
- 12 -
frequently visiting family members who were also involved in
Amway. We find that this factor remains neutral.
As previously stated, more weight must be given to objective
facts indicating a profit objective than to petitioners’
statement of intent. Dreicer v. Commissioner, supra. After
considering the objective factors detailed above, we find
especially relevant the manner in which petitioners carried on
the Amway activity and petitioners’ history of losses and lack of
profits. We find from these and the other objective facts in the
record that petitioners did not have an actual and honest intent
to profit from the Amway activity in 1996 and 1997.
Reviewed and adopted as the report of the Small Tax Case
Division.
To reflect the foregoing,
Decision will be entered
for respondent.