                  T.C. Summary Opinion 2007-138



                      UNITED STATES TAX COURT



         ROBERT D. AND CAROL A. BERRYMAN, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 15183-06S.             Filed August 8, 2007.



     Robert D. and Carol A. Berryman, pro se.

     Ann L. Darnold, for respondent.



     GOEKE, Judge:   This case was heard pursuant to the

provisions of section 74631 of the Internal Revenue Code in

effect at the time the petition was filed.   Pursuant to section

7463(b), the decision to be entered is not reviewable by any




     1
      All section references are to the Internal Revenue Code in
effect for the years at issue.
                                 - 2 -

other court, and this opinion shall not be treated as precedent

for any other case.

     Petitioners operated a purported home-based business as

marketers for a direct marketing company.      Respondent determined

deficiencies of tax of $11,824, $7,845, and $13,983 for tax years

2002, 2003, and 2004, respectively.      Respondent also imposed

penalties of $2,364.80, $1,569, and $2,796.60 for 2002, 2003, and

2004, respectively.   Because petitioners’ marketing activities

were not for profit, and because petitioners failed to

substantiate part of their 2002 home mortgage interest deduction,

we sustain respondent’s determinations.

                            Background

     Some of the facts have been stipulated and are so found.

Petitioners are husband and wife and resided in Tulsa, Oklahoma

at the time their petition was filed.      Petitioners are both

employed full time, Mr. Berryman with the Cimarron Telephone Co.

and Mrs. Berryman as a teacher in a local public school system.

     Beginning in 1992, petitioners became involved with a

company called Melaleuca, Inc.    Melaleuca is a direct marketing

company which sells a line of health and wellness products.

Melaleuca calls their distributors marketing executives.      As

Melaleuca marketing executives, petitioners agreed to purchase a

certain volume of Melaleuca products which they received at a

discount.   Petitioners could then earn commissions by recruiting
                               - 3 -

others to join Melaleuca.   The amount of commissions petitioners

would receive was determined by the number of individuals

recruited as well as the volume of products that these

individuals signed up to purchase from Melaleuca.

     Prior to their involvement with Melaleuca, petitioners had

no experience in running a business.    Despite this lack of

experience, petitioners did little to educate themselves in the

economics or logistics of operating a profitable business and

instead relied solely on the guidance provided by Melaleuca

insiders.

     Petitioners hired their son to help set up and maintain an

accounting system on their home computer.    Petitioners used this

system to track the income and expenses related to Melaleuca.

Petitioners did not, however, use this accounting system to help

evaluate their business or try to make it more profitable.     In

addition, petitioners did not create or maintain any business

plan or budgets with respect to their Melaleuca marketing

activities.

     Petitioners’ attempts to recruit other marketing executives

consisted of hosting gatherings of friends and acquaintances in

their home, where petitioners would present Melaleuca and try to

persuade these individuals to join.    There is no evidence,

however, that petitioners advertised these gatherings by any

means other than word of mouth.   Petitioners achieved limited
                                - 4 -

success in actually recruiting others to join Melaleaca.   For

each individual petitioners were able to recruit, petitioners

received a commission from $10 to $150.

     Petitioners timely filed their Federal income tax returns

with attached Schedules C, Profit or Loss From Business, for the

years in issue.    On their respective Schedules C for 2002, 2003,

and 2004, petitioners reported gross receipts from their

Melaleuca activities of $5,300, $3,674, and $3,030.   Petitioners

then claimed losses of $49,590, $45,114, and $67,738 for 2002,

2003, and 2004, respectively.   These losses included numerous

personal expenses claimed as business deductions.   For instance,

petitioners claimed deductions for cat litter, golf balls,

tickets to Oklahoma State University football games, and a Dish

Network subscription.   Petitioners also claimed a deduction for a

life insurance policy they purchased.   Petitioners offset these

losses against combined wages of $95,824, $91,662, and $103,693

for 2002, 2003, and 2004, respectively.

     In the notice of deficiency, respondent disallowed the

losses claimed on the Schedules C and asserted penalties under

section 6662(a).   In addition, for 2002, respondent disallowed

$1,462 of petitioners’ claimed mortgage interest deduction, for

lack of substantiation.
                                 - 5 -

                             Discussion

A.   Petitioners’ Direct Marketing Activities

     Section 183 restricts taxpayers from deducting losses from

an activity that is not “engaged in for profit”.   Sec. 183(a).

An activity is engaged in for profit if the taxpayer entertained

an actual and honest profit objective in engaging in the

activity.   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); sec. 1.183-2(a), Income

Tax Regs.   The taxpayer’s expectation of profit must be in good

faith.   Allen v. Commissioner, 72 T.C. 28, 33 (1979) (citing sec.

1.183-2(a), Income Tax Regs.).

     In deciding whether petitioners operated their direct

marketing activities for profit, we consider the following nine

factors:    (1) The manner in which they carried on the activity;

(2) their expertise or that of their advisers; (3) the time and

effort they expended in carrying on the activity; (4) the

expectation that the assets they used in the activity may

appreciate in value; (5) their success in carrying on other

similar or dissimilar activities; (6) their history of income or

loss with respect to the activity; (7) the amount of occasional

profits, if any, which they earned; (8) their financial status;

and (9) whether elements of personal pleasure or recreation are

involved.   See sec. 1.183-2(b)(1) through (9), Income Tax Regs.
                                - 6 -

     No single factor, nor even the existence of a majority of

factors favoring or disfavoring the existence of a profit

objective, is controlling.     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.    Rather, the relevant facts and

circumstances of the case are determinative.     See Golanty v.

Commissioner, 72 T.C. 411, 426 (1979), affd. without published

opinion 647 F.2d 170 (9th Cir. 1981).

     After careful consideration, we are satisfied that

petitioners did not engage in the marketing of Melaleuca products

with a profit objective.2    Petitioners did not prepare or

maintain any business plans, financial projections, or budgets

with respect to their Melaleuca activities.     While petitioners

used a computerized accounting program to track income and

expenses, there is no evidence that petitioners used that

information to try to make their activities profitable.       See id.

at 430.

     Before becoming Melaleuca marketing executives, petitioners

had no experience in running a business.     Nevertheless, they did

not seek independent business advice at the outset nor after

sustaining year after year losses.      Instead, at most, petitioners


     2
      We note that petitioners did not argue to shift the burden
of proof under sec. 7491(a). Regardless, the outcome of this
case is determined on the preponderance of the evidence after
trial and is unaffected by sec. 7491(a). See Estate of Bongard
v. Commissioner, 124 T.C. 95, 111 (2005).
                                - 7 -

relied upon Melaleuca insiders.   This failure to become educated

in the economics of operating a profitable home-based business

strongly suggests that petitioners were using and marketing

Melaleuca products for purposes other than profit.    See Ogden v.

Commissioner, T.C. Memo. 1999-397, affd. 244 F.3d 970 (5th Cir.

2001).

     Petitioners’ Melaleuca activities have resulted in

substantial losses.   While losses that are incurred in the

initial stages of an activity do not necessarily suggest the

absence of an honest profit objective, losses that continue

without explanation may indicate the lack of a profit objective.

See Golanty v. Commissioner, supra at 427.     Petitioners reported

losses of $49,590, $45,114, and $67,738, for the years at issue.

This after having already been involved with Melaleuca since

1992.    Further, despite these year after year losses, there is no

evidence that petitioners changed tactics to increase the

likelihood of earning a profit.

     Both petitioners worked full-time jobs.    This left little

time for petitioners to spend on their Melaleuca activities.

Despite this apparent lack of time, Mr. Berryman testified that

on as many as five nights a week, petitioners would host

gatherings of between 1 and 25 prospective customers.    We find

Mr. Berryman’s testimony lacked credibility, especially in the
                               - 8 -

absence of any efforts on the part of Mr. Berryman to locate

these prospective customers other than by word of mouth.

     The one financial success, at least before respondent caught

on, that petitioners enjoyed with their Melaleuca activities was

offsetting their losses against wages of $95,824, $91,662, and

$103,693 for 2002, 2003, and 2004, respectively, to create

substantial tax savings.   Of course, this itself is an indication

that petitioners were more interested in the tax savings realized

by converting personal expenses into tax deductions than they

were with operating a business for profit.

     In sum, we are satisfied that petitioners’ primary purpose

for engaging in the promotion of Melaleuca products was not to

profit.   Accordingly, petitioners are not entitled to the

deductions here in dispute beyond those allowed by respondent

under section 183(b).

B.   Petitioners’ 2002 Home Mortgage Interest Deduction

     Respondent also adjusted the home mortgage interest

deduction claimed by petitioners in 2002 by $1,462 for lack of

substantiation that they paid such interest.    Section 163(h)

allows a deduction for interest paid on a qualified residence.

Sec. 163(h)(2)(D). “Qualified residence” within the meaning of

section 163 may be either the taxpayer’s principal residence or

another residence selected by the taxpayer and used as a

residence.   Sec. 163(h)(4)(A)(i).   As with any deduction,
                                - 9 -

petitioners must be able to substantiate the amount claimed.    See

sec. 6001; sec. 1.6001-1(a), Income Tax Regs.

     Petitioners provided no documentation before, during, or

after trial, such as canceled checks, that would substantiate

their claim that they made payments of home mortgage interest in

excess of the $10,123 allowed by respondent for 2002.    At trial,

Mr. Berryman did not testify as to any specific payments of home

mortgage interest and included as an exhibit the Forms 1098,

Mortgage Interest Statement, only for taxable years 2003 and

2004.    Accordingly, without any evidence that petitioners

actually paid the $1,462, we sustain respondent’s adjustment with

respect to petitioners’ 2002 itemized mortgage interest

deduction.

C.   Section 6662(a) Accuracy-Related Penalties

     Finally, we address respondent’s assertion of penalties

under section 6662(a) and (b).3   Section 6662(a) and (b)(1)

provides that if any portion of an underpayment of tax is

attributable to negligence or disregard of rules or regulations,

there shall be added to the tax an amount equal to 20 percent of

the amount of the underpayment that is so attributable.    The term


     3
      Respondent bears the burden of production with respect to
the accuracy-related penalties. Sec. 7491(c). In order to meet
this burden of production, respondent must produce sufficient
evidence that it is appropriate to impose the accuracy-related
penalties. Once respondent has done so, the burden of proof is
upon petitioners. Higbee v. Commissioner, 116 T.C. 438, 449
(2001).
                                - 10 -

“negligence” includes any failure to make a reasonable attempt to

comply with the provisions of the Internal Revenue Code, and any

failure to keep adequate books and records or to substantiate

items properly, and the term “disregard” includes any careless,

reckless, or intentional disregard.      Sec. 6662(c); sec.

1.6662-3(b)(1) and (2), Income Tax Regs.      No penalty shall be

imposed if it is shown that there was reasonable cause for the

underpayment and the taxpayer acted in good faith with respect to

the underpayment.   Sec. 6664(c).

     While petitioners are by no means sophisticated in matters

related to tax, the manner in which petitioners operated their

purported business and the character of the deductions claimed as

part of that purported business, convince us that the

underpayment of tax for each year was attributable to a disregard

of the rules and regulations.    For instance, petitioners claimed

deductions for the cost of cat litter, a Dish Network

subscription, and a life insurance policy.

     Petitioners rely on Nitschke v. Commissioner, T.C. Memo.

2000-230, for support that Melaleuca is a business.      In Nitschke,

the Commissioner challenged whether certain claimed expenses of

the taxpayer, related to Melaleuca activities, were ordinary and

necessary under section 162(a) and did not challenge whether the

taxpayer was operating their Melaleuca activities for profit.

Thus, our decision in Nitschke is of no relevance to whether
                              - 11 -

petitioners here were carrying on their Melaleuca activities for

profit.   Accordingly, respondent’s determination that petitioners

are liable for accuracy-related penalties under section 6662(a)

is sustained.

     To reflect the foregoing,


                                      Decision will be entered for

                                 respondent.
