T.C. Memo. 2004-249
UNITED STATES TAX COURT
DUANE A. DWORSHAK, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 15268-02. Filed November 3, 2004.
Duane A. Dworshak, pro se.
Linette Angelastro, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
COLVIN, Judge: Respondent determined a deficiency in
petitioner’s Federal income tax of $3,875 for 1997 and an
addition to tax for failure to timely file under section
6651(a)(1) of $305.
After concessions, the issues for decision are:
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1. Whether petitioner operated his direct marketing
activity for profit in 1997. We hold that he did.
2. Whether petitioner may deduct business expenses for 1997
in an amount greater than respondent conceded. We hold that he
may not.
3. Whether petitioner is liable for an addition to tax
under section 6651(a)(1) for failure to timely file his return
for 1997. We hold that he is.
Section references are to the Internal Revenue Code as
amended and in effect for 1997. Rule references are to the Tax
Court Rules of Practice and Procedure.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found.
A. Petitioner
Petitioner resided in California City, California, when he
filed his petition.
Petitioner has been employed by the Los Angeles County
Probation Department since 1984. Petitioner was employed as a
supervisor at a juvenile detention camp at all times relevant to
this case. Petitioner received wages from Los Angeles County of
$41,139 in 1995, $42,372 in 1996, and $48,913 in 1997.
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B. Cell Tech
Around 1995, petitioner purchased and began using some
health care and nutritional products sold by the Cell Tech Co.
(Cell Tech). Petitioner liked the Cell Tech products he used.
Cell Tech directly marketed and distributed its products to
the public through outside sales representatives. The Cell Tech
sales representative who sold petitioner these products asked him
whether he wanted to become a Cell Tech sales representative. As
a Cell Tech sales representative petitioner could earn
commissions on: (1) Customer orders of Cell Tech products placed
through him; and (2) customer orders placed through other Cell
Tech representatives recruited by petitioner and other Cell Tech
representatives recruited by them and their recruits. The Cell
Tech sales representative told petitioner that she knew of
several Cell Tech representatives who earned sizable commissions.
Petitioner became a Cell Tech representative in June 1995.
Cell Tech was his first independent business venture. Petitioner
was interested in engaging in an activity that would supplement
or eventually replace his income from the Probation Department.
Petitioner believed that his income from direct marketing would
increase sufficiently to eventually replace his wages from the
Probation Department.
The sales representative told petitioner that to get started
he would need to spend about $2,000 for: (1) Cassette tapes and
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other sales materials promoting Cell Tech and its products, (2) a
mailing list of potential customers, and (3) mailing envelopes in
which to enclose the cassette tapes and sales materials.
From June 1995 through most of 1996, petitioner mailed Cell
Tech sales material packages to potential customers. About 2
percent of the people to whom he mailed materials purchased
products from him during that time.
Petitioner planned to increase the quantity of the products
he sold and the number of sales representatives he recruited. He
tested products, evaluated potential companies, and tried to
identify the most efficient method of selling products.
Petitioner also bought and read books and periodicals about
direct marketing in general and specific companies for which he
became or was considering becoming a sales representative.
Petitioner kept records of his customer base, his mailings and
whether they resulted in sales or recruits, and his income and
expense receipts for his marketing activity.
By late 1996, petitioner had become dissatisfied with being
a Cell Tech representative. In late 1996 and in 1997, the
positive response to petitioner’s Cell Tech mailings declined to
less than .5 percent, and many of his customers stopped buying
Cell Tech products. Petitioner concluded that it was not
productive for him to continue mailing Cell Tech materials. He
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stopped mailing unsolicited sales materials to potential
customers and began using telephone calls and meetings to make
sales. Although petitioner continued to be a Cell Tech
representative, he reduced his efforts to sell Cell Tech products
and began to look for sales positions with other direct marketing
companies.
C. Other Companies
Petitioner used some products from other companies to decide
whether he wanted to sell those products. In 1996 and 1997,
petitioner considered becoming a sales representative for several
other direct marketing companies such as Awareness Co., Telecard
Network Co., The People’s Network (TPN), and Vaxa Co. In 1996
and 1997, petitioner briefly sold telephone cards as a Telecard
Network Co. representative, but he stopped when he concluded that
he could not produce the profits he sought.
Petitioner became a TPN representative in 1997. TPN sold
subscriptions to the TPN satellite television channel, household
and personal care products, and vitamins offered on TPN’s
satellite channel and in TPN’s sales catalog. The TPN satellite
channel also featured motivational speakers who provided advice
and guidance to individuals on self-improvement and/or personal
development. As a TPN representative, petitioner earned
commissions on subscribers he brought to the TPN satellite
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channel and on any TPN products purchased by his customers from
the TPN satellite channel or sales catalog.
Petitioner focused his marketing activity on selling TPN and
its products. He called and sent TPN cassettes, videotapes, and
sales materials to potential customers of TPN products.
In 1997, petitioner attended several conferences for TPN
representatives in Dallas, Texas, where TPN was headquartered.
The conferences featured direct marketing industry professionals
and suppliers of TPN materials and products.
Petitioner made lists of people he believed were potential
customers of TPN products and who might be interested in becoming
sales representatives. Petitioner met with these people and
distributed sales materials to them. From June 1995 to December
1997, petitioner spent 10 to 20 hours per week on his marketing
activity.
D. Petitioner’s Tax Returns
Petitioner reported gross income, expenses, and losses from
his marketing activity on his 1995, 1996, and 1997 returns, and
respondent conceded that petitioner substantiated business
expenses for 1997, as follows:
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Amount
respondent
concedes
petitioner
Reported by petitioner substantiated
1995 1996 1997 for 1997
Other income:
Commissions $2,307 $7,326 $2,070
Gross income 2,307 7,326 2,070
Expenses:
Advertising 5,224 2,643 2,955 $2,955
Car and truck 918 1,530 1,861 1,861
Depreciation 507 348 318 -0-
Legal and - 50 - -
professional
services
Repairs and 70 - - -
maintenance
Supplies 265 357 315 -0-
Travel - 497 1,290 267
Meals and - 594 1,394 1,395
entertainment
Utilities 327 737 617 -0-
Other:
Business courses 126 473 409 -0-
Books 22 442 97 -0-
Subscriptions 62 206 522 -0-
Business education - 329 645 -0-
Distributorship/ 1,515 233 1,320 1,320
franchise fees
New product - 2,896 784 -0-
samples
Product testing 1,379 2,490 4,616 1,846
Total expenses 10,415 13,825 17,143 9,644
Net loss (8,108) (6,499) (15,073)
Petitioner untimely filed his return for 1997 on September
15, 1999. Petitioner reported on the Schedule C, Profit or Loss
From Business, he attached to that return that his principal
business and product or service was “Network Marketing: Personal
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Care, Nutritional Products, Personal Development and Distributor
Services”.
OPINION
A. Whether Petitioner Operated His Direct Marketing Activity
for Profit in 1997
1. Background
The issue for decision is whether petitioner operated his
direct marketing activity for profit in 1997. The parties agree
that petitioner’s undertakings as a sales representative for
various direct marketing companies are one activity.
A taxpayer conducts an activity for profit if he or she does
so with an actual and honest profit objective. Surloff v.
Commissioner, 81 T.C. 210, 233 (1983); Dreicer v. Commissioner,
78 T.C. 642, 645 (1982), affd. without opinion 702 F.2d 1205
(D.C. Cir. 1983). In deciding whether petitioner operated the
direct marketing activity for profit, we consider the following
nine factors: (1) The manner in which the taxpayer carried on
the activity; (2) the expertise of the taxpayer or his advisers;
(3) the time and effort 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
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earned; (8) the financial status of the taxpayer; and (9) whether
elements of personal pleasure or recreation are involved. Sec.
1.183-2(b)(1) through (9), Income Tax Regs. No single factor
controls. Brannen v. Commissioner, 722 F.2d 695, 704 (11th Cir.
1984), affg. 78 T.C. 471 (1982); sec. 1.183-2(b), Income Tax
Regs.
2. Applying the Factors
Respondent contends that the factors in section 1.183-2(b),
Income Tax Regs., favor respondent, except respondent agrees that
the appreciation of assets factor does not apply.
Respondent contends that petitioner did not conduct his
activity in a businesslike manner, keep proper books and records,
or have a business plan. We disagree. A business plan may be
evidenced by actions of the taxpayers where there is no written
business plan. Phillips v. Commissioner, T.C. Memo. 1997-128.
Petitioner’s actions show that he had an informal business plan.
He expected to improve his business by increasing the number of
customers and recruiting more sales representatives. He sought
to identify the best companies with which to do business, the
best products for sale, and the most efficient method for
marketing those products and for recruiting sales
representatives. He expected that his income from his marketing
activity would ultimately replace his wages from the Probation
Department.
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Petitioner kept records of income and expenses from his
marketing activities, and he kept records of the success rates of
his mailings and the size of his customer base.
A change of operating methods or abandonment of unprofitable
methods in a manner consistent with an intent to improve
profitability may indicate a profit objective. Krebs v.
Commissioner, T.C. Memo. 1992-154; Pirnia v. Commissioner, T.C.
Memo. 1989-627; sec. 1.183-2(b)(1), Income Tax Regs. Beginning
late in 1996, petitioner made numerous changes in his direct
marketing activity in an attempt to make a profit. Petitioner
searched for different companies for which to sell, and he
changed his methods when they were not successful. He obtained
sales positions with other direct marketing companies after he
became dissatisfied with being a Cell Tech representative. He
stopped sending unsolicited Cell Tech mailings after concluding
they were ineffective as a sales technique and began to use
telephone calls and meetings to make sales. He briefly became a
Telecard Network Co. representative in 1996 and 1997 but stopped
when he concluded that the Telecard Network Co. would not produce
the profits he sought. In 1997, he became a TPN representative
and concentrated his efforts on selling TPN and its products.
This factor favors petitioner.
Respondent contends that petitioner lacked any expertise in
direct marketing. We disagree. Efforts at gaining experience
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and a willingness to follow expert advice may indicate a profit
objective. Krebs v. Commissioner, supra. Similarly, preparation
for an activity by study of its accepted business, economic, and
scientific practices, and consultation with those who are expert
therein, may indicate that the taxpayer entered into the activity
for profit. Id.; Pirnia v. Commissioner, supra; sec. 1.183-
2(b)(2), Income Tax Regs. Petitioner read books and periodicals
and attended workshops and conferences to learn about direct
marketing. This factor favors petitioner.
From June 1995 to December 1997, petitioner worked 10 to 20
hours per week on his marketing activity. Respondent concedes
that petitioner spent a significant amount of time on this
activity. Respondent contends that petitioner should have been
doing more than he did, but respondent does not say what else
petitioner should have done. This factor favors petitioner.
Petitioner had no previous success in similar activities.
This factor favors respondent.
Respondent contends that the fact that petitioner had losses
from his marketing activity in 1995, 1996, and 1997 shows that
petitioner did not have a profit objective. We disagree. Losses
incurred during the startup stage of an activity do not indicate
that the activity is not operated for profit if the taxpayer’s
losses were not sustained for a period beyond that which is
reasonably necessary for him or her to achieve a profit.
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Bessenyey v. Commissioner, 45 T.C. 261, 274 (1965), affd. 379
F.2d 252 (2d Cir. 1967). This factor is neutral.
Respondent contends that the financial status factor favors
respondent because petitioner was employed full time. We
disagree. Petitioner earned wages of less than $50,000 per year
in 1995, 1996, and 1997. It does not appear that his aim was to
shelter income from tax. This factor favors petitioner.
Respondent contends that petitioner conducted his direct
marketing activity because he derived pleasure from it. We
disagree. We do not believe petitioner derived a significant
amount of personal pleasure from his direct marketing activity.
This factor favors petitioner.
We have previously decided whether various direct marketers
had profit objectives. For example, we held that the taxpayers
lacked a profit objective in Elliott v. Commissioner, 90 T.C.
960, 969-973 (1988), affd. without published opinion 899 F.2d 18
(9th Cir. 1990); Nissley v. Commissioner, T.C. Memo. 2000-178;
and Poast v. Commissioner, T.C. Memo. 1994-399. In those cases,
the taxpayers derived significant amounts of personal pleasure
from their Amway activities through hosting social gatherings in
their homes for prospective customers and attending conventions
and seminars for Amway representatives, thus using the marketing
activity to deduct personal travel expenses as business expenses.
See, e.g., Elliott v. Commissioner, supra (week in Hawaii);
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Nissley v. Commissioner, supra (trips to New York, Denver,
Atlanta, Orlando, and Minneapolis); Poast v. Commissioner, supra
(repeated trips to the Indianapolis Speedway, and trips to
Washington, D.C., California, Texas, and Michigan).1
Petitioner did not use his marketing activity to deduct personal
travel expenses. The taxpayers in Nissley said they would
continue selling Amway products whether or not they were
financially successful. Here, as discussed above, petitioner
changed companies and abandoned unsuccessful sales methods.
Respondent does not contend that this case is like the Amway
cases.
In view of the time and effort petitioner spent on his
marketing activity, the startup nature of the activity, and his
changes in operations and abandonment of unprofitable methods, we
find that petitioner operated his direct marketing activity for
profit in 1997.2
1
The Commissioner conceded that the taxpayer in Brennan v.
Commissioner, T.C. Memo. 1997-60, engaged in an Amway sales
activity for profit.
2
Respondent’s counsel stated at trial that petitioner
“probably intended to make a profit” from 1995 to 1997 as an
outside sales representative for direct marketing companies.
However, we have decided this issue on the record, not on the
basis of respondent’s counsel’s statement at trial.
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B. Whether Petitioner May Deduct More Business Expenses Than
Respondent Conceded
Petitioner contends that he may deduct more expenses for his
direct marketing activity for 1997 than respondent conceded
($9,644). We disagree. At trial, petitioner admitted that some
of the products he bought may have been for his own use and not
for product-testing purposes. Petitioner did not offer credible
evidence that he had more direct marketing expenses for 1997 than
the $9,644 that respondent conceded.
C. Whether Petitioner Is Liable for the Addition to Tax for
Failure To Timely File His 1997 Income Tax Return
A taxpayer is liable for an addition to tax up to 25 percent
for failure to timely file a return unless the failure was due to
reasonable cause and not willful neglect. Sec. 6651(a)(1).
Respondent has met the burden of production under section
7491(c) as to the addition to tax for failure to timely file
under section 6651(a)(1) because petitioner filed his 1997 return
on September 15, 1999, 17 months after it was due on April 15,
1998. Secs. 6072(a), 6012(a)(1).
Petitioner testified that he filed his return late because
he was busy with his marketing activity. This is not reasonable
cause for late filing. Dustin v. Commissioner, 53 T.C. 491, 507
(1969), affd. 467 F.2d 47 (9th Cir. 1972). Petitioner made no
other argument that he is not liable for this addition to tax.
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We hold that petitioner is liable for the addition to tax under
section 6651(a)(1) for failure to timely file his 1997 return.
To reflect concessions and the foregoing,
Decision will be
entered under Rule 155.