                       T.C. Memo. 2003-142



                     UNITED STATES TAX COURT



        JORGE N. LOPEZ AND VIVIAN LOPEZ, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 8612-01.               Filed May 20, 2003.



     Jorge N. Lopez and Vivian Lopez, pro sese.

     David B. Mora, for respondent.



                       MEMORANDUM OPINION


     CARLUZZO, Special Trial Judge:   Respondent determined

deficiencies of $3,833 and $3,810 in petitioners’ Federal income

taxes for the years 1998 and 1999, respectively.   The issue for

decision for each year is whether petitioners are entitled to

deductions for expenses incurred in connection with the sale and
                               - 2 -

distribution of Amway Corp. (Amway) products.   The resolution of

this issue for each year depends upon whether petitioners’ Amway

distributorship was a trade or business within the meaning of

section 162.1

Background

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

Petitioners are husband and wife.   They filed a timely joint

Federal income tax return for each year in issue.   At the time

the petition was filed, petitioners resided in Houston, Texas.

     Jorge Lopez holds a bachelor’s and a master’s degree in

petroleum engineering.   At all relevant times he was employed

full time as a petroleum engineer by Altura Energy, Ltd.   Vivian

Lopez described her occupation as housewife and homemaker.

     In 1996, an “upline”2 distributor of Amway products

recruited petitioners to act as “downline” distributors.

Petitioners maintained this status throughout the years in issue.

Some time after 1999, petitioners ceased their Amway activity and

became involved in Quixtar, Inc., an Amway affiliate.




     1
       Unless otherwise indicated, section references are to the
Internal Revenue Code in effect for the years in issue, and Rule
references are to the Tax Court Rules of Practice and Procedure.
     2
       The term “upline” simply refers to one’s relative position
in a particular distribution chain of Amway products. One
becomes an upline distributor after successfully recruiting one
or more “downline” distributors.
                               - 3 -

     Amway is widely known as a marketer and supplier of various

personal and household products.   Amway relies on distributors

to purchase such products for personal consumption and for

resale to customers and downline distributors.3   In general, a

distributor’s gross income is based on profit from retail sales,

plus a “performance bonus” that is controlled by Amway and is

influenced by the type and quantity of products the distributor

purchases from Amway.

     Profit from retail sales is determined by the difference

between the wholesale price, which is set by Amway, and the

retail price, which is set by the distributor.    On average,

Amway’s suggested retail price for each product is approximately

25 percent above wholesale, but distributors are entitled to sell

a product at whatever price they choose, even if a sale at that

price produces a loss.   Petitioners’ practice was to sell

products to their customers and downline distributors at cost,

thereby eliminating product sales as a source of profit.

     A distributor’s performance bonus is determined by his or

her “point value” and “business volume”.   Point value is a

unitless number that corresponds to a particular tier in the

Amway “performance bonus schedule”.    Business volume is a dollar

amount generally equivalent to 87 percent of the suggested retail


     3
       A customer purchases Amway products for personal
consumption, but a distributor purchases Amway products intending
to resell them to customers or other distributors.
                                 - 4 -

price of a particular product.    Amway assigns a given point value

and business volume to each product it sells but may change these

figures at any time for any reason it chooses.4   Consequently, it

is difficult to predict a performance bonus on the basis of the

present point value and business volume of Amway products.    The

performance bonus is calculated by multiplying a distributor’s

monthly business volume by a percentage that is listed in the

performance bonus schedule and corresponds to the distributor’s

monthly point value.5   This percentage ranges from 3 to 25

percent and increases in steps as a function of point value.

     Petitioners’ Amway activities may be summarized as follows.

Petitioners were recruited by an upline distributor of Amway

products in 1996.   Petitioners had no prior experience with Amway

and no prior experience running a business.   Before becoming

Amway distributors, petitioners received advice from other Away

distributors but did not seek the advice of independent business

consultants.   During the course of their affiliation with Amway,

petitioners relied on the advice of certain celebrated upline


     4
       According to petitioners’ exhibits, the ratio of business
volume to point value ranges from 2.00 to 2.62.
     5
       For example, assume that, in a given month, a distributor
accumulates a point value of 1,000 and a business volume of
$2,500. According to Amway’s performance bonus schedule, at a
point value of 1,000, the performance bonus equals 12 percent of
business volume. Thus, in this example, the gross performance
bonus is $300 (i.e., $2,500 x 0.12). To determine the
distributor’s net performance bonus, this amount must be reduced
by the dollar amount of bonuses owed to downline distributors.
                                - 5 -

distributors of Amway products.    Petitioners also received

unsolicited, independent advice from their accountant, but

apparently the advice was negative.

     Instead of attempting to sell Amway products at a profit to

customers/users, petitioners chose to concentrate on developing a

network of distributors.    Consequently, their potential for

profit was almost entirely dependent upon Amway’s performance

bonus program and the sales efforts of their downline

distributors.   Recruiting productive downline distributors,

therefore, was the key to petitioners’ profit potential.

Nevertheless, they made no effort to develop a profile of a

successful downline distributor on which basis they would

recruit; instead, petitioners recruited indiscriminately from

family, friends, and acquaintances.     By the end of 1999, it

appears that petitioners had recruited between 10 and 25 downline

distributors but had only two regular customers--their neighbor

and Mr. Lopez’s mother.

     The relationship between petitioners and their downline

distributors was an informal one.    There were no contracts or

minimum sales agreements.    Downline distributors were free to

leave petitioners’ distribution network at will and, if they

desired, could even join another Amway distributorship under a

different upline distributor.    Petitioners were not assigned a

sales territory, and, like their downline distributors, they had
                               - 6 -

to compete with other Amway affiliates for sales and recruits.

Petitioners’ lack of control over their downline distributors

hampered their ability to predict sales and, in turn, performance

bonuses.   Their difficulty in predicting performance bonuses was

compounded by Amway’s practice of varying the point value it

assigned to a given product.   Petitioners’ lack of control over

these key components of their distributorship caused any

predictions of performance bonuses that they might have made to

be, at best, uncertain.

     Given their practice of selling Amway products at cost,

petitioners’ Amway distributorship could be profitable only if

their performance bonuses exceeded their expenses.    In order for

this to occur, petitioners estimated that they would need to

achieve and maintain a monthly point value of 4,000.    However,

petitioners had not actually made this determination for

themselves; rather, they relied on statements to this effect

by other Amway distributors and hypothetical examples in

Amway brochures.   During the years in issue, it appears that

petitioners’ point value did not exceed 372 in any given month.

     As noted, petitioners filed a timely joint Federal income

tax return for each year in issue.     Included with each return is

a Schedule C, Profit or Loss From Business.    Petitioners’

Schedule C for 1998 lists their principal business as “Amway

Sales and Distribution”.   For 1999, petitioners’ Schedule C lists
                                - 7 -

their principal business as “Sales:Distribution”.     Petitioners

reported their Schedule C income and expenses for the years in

issue as follows:

     Income:                              1998       1999
       Gross receipts or sales           $7,139     $7,061
         Less: cost of goods sold         3,439      6,368
       Gross income                       3,700        693

     Expenses:
       Car/truck expenses                $6,901     $6,238
       Supplies                             500        503
       Travel                               911      2,172
       Meals/entertainment                  742        868
       Utilities                          2,248      2,130

     Other expenses:
       Misc. business expense               325        330
       Tools                              7,774      4,752
       Functions                          2,687      2,060
         Total expenses                  22,088     19,053

     Net profit or (loss)               (18,388)   (18,360)


     Petitioners prepared a budget applicable to both years in

issue.   According to the budget, which consists of a single

handwritten page, financing petitioners’ Amway activity would

cost $737 per month, or $8,844 per year.      The expenses deducted

on petitioners’ returns are more than double the budgeted amount.

     In the notice of deficiency, respondent disallowed

petitioners’ Schedule C expenses on the ground that petitioners’

Amway activity was not entered into for profit.     However, to

the extent of income realized from this activity, respondent

allowed these expenses as miscellaneous itemized deductions on
                               - 8 -

Schedule A, Itemized Deductions.   Other adjustments made in the

notice of deficiency are not in dispute.

Discussion

     Burden of Proof

     As a general rule, determinations made by the Commissioner

in the notice of deficiency are presumed to be correct, and the

taxpayer bears the burden of proving otherwise.    See Rule 142(a);

Welch v. Helvering, 290 U.S. 111, 115 (1933).     Moreover, it is

settled that “‘an income tax deduction is a matter of legislative

grace and that the burden of clearly showing the right to the

claimed deduction is on the taxpayer.’”    INDOPCO, Inc. v.

Commissioner, 503 U.S. 79, 84 (1992) (quoting Interstate Transit

Lines v. Commissioner, 319 U.S. 590, 593 (1943)).     Pursuant to

section 7491(a), if the taxpayer introduces credible evidence

with respect to any factual issue relevant to ascertaining the

taxpayer’s liability for tax, the burden of proof is placed on

the Commissioner with respect to that issue.    For the burden of

proof to shift to the Commissioner, however, the taxpayer must

cooperate with reasonable requests by the Commissioner for

witnesses, information, documents, meetings, and interviews.

See sec. 7491(a)(2)(B); Higbee v. Commissioner, 116 T.C. 438,

441 (2001).   Petitioners failed to satisfy this requirement

insofar as they refused to meet with respondent’s counsel before

trial, refused to provide respondent’s counsel with copies of
                                - 9 -

documents on which they intended to rely at trial, and refused to

participate in the stipulation process contemplated by Rule 91.6

     Trade or Business

     According to petitioners, their Amway activity, at all

relevant times, was a trade or business.    Therefore, petitioners

argue, the expenses they incurred in carrying on this activity

should be allowed as deductions.    See sec. 162(a).7   Respondent

argues that petitioners were not carrying on a trade or business

because they lacked the requisite profit objective, and

petitioners are not, therefore, entitled to the deductions

they claim, except to the extent allowed by section 183.8



     6
       Petitioners explained that their refusal to cooperate with
respondent’s counsel was caused by their mistaken beliefs that
(1) they elected to have this case heard as a small tax case
pursuant to sec. 7463, and (2) the parties in a small tax case
are not required to meet in order to properly prepare for trial.
     7
       In general, sec. 162(a) allows a deduction for the
ordinary and necessary expenses paid or incurred during the
taxable year in carrying on any trade or business.
     8
         In relevant part, sec. 183 provides:

          SEC. 183(a). General Rule.–-In the case of an
     activity engaged in by an individual or an S
     corporation, if such activity is not engaged in for
     profit, no deduction attributable to such activity
     shall be allowed under this chapter except as
     provided in this section.

          (b) Deductions Allowable.–-In the case of an
     activity not engaged in for profit to which subsection
     (a) applies, there shall be allowed--
                                                   (continued...)
                              - 10 -



For the following reasons, we agree with respondent.

     The term “trade or business” is not precisely defined in

section 162 or the regulations promulgated thereunder; however,

it is well established that in order for an activity to be

considered a taxpayer’s trade or business for purposes relevant

here, the activity must be conducted “with continuity and

regularity” and “the taxpayer’s primary purpose for engaging in

the activity must be for income or profit.”   Commissioner v.

Groetzinger, 480 U.S. 23, 35 (1987).

     The test for whether a taxpayer conducted an activity for

profit is whether he or she entered into, or continued, the

activity with the actual or honest objective of making a profit.

See 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.   The taxpayer’s profit objective for each


     8
      (...continued)

          (1) the deductions which would be allowable under
     this chapter for the taxable year without regard to
     whether or not such activity is engaged in for profit,
     and

          (2) a deduction equal to the amount of the
     deductions which would be allowable under this chapter
     for the taxable year only if such activity were engaged
     in for profit, but only to the extent that the gross
     income derived from such activity for the taxable year
     exceeds the deductions allowable by reason of paragraph
     (1).
                              - 11 -

year in which the activity is conducted must be bona fide, taking

into account all of the facts and circumstances.   See Keanini v.

Commissioner, supra at 46; Dreicer v. Commissioner, supra at 645;

Golanty v. Commissioner, 72 T.C. 411, 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); sec. 1.183-2(a) and (b), Income Tax Regs.   More

weight is given to objective facts than to the taxpayer’s

subjective statement of intent.   See Engdahl v. Commissioner,

72 T.C. 659, 666 (1979); sec. 1.183-2(a), Income Tax Regs.

     The following factors, which are nonexclusive, aid in

determining whether an activity is engaged in for profit:

(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 expended by the taxpayer in carrying on the

activity; (4) the expectation that 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)

elements of personal pleasure or recreation.   See sec. 1.183-

2(b), Income Tax Regs.   No one factor is determinative in and of

itself, and our conclusion with respect to petitioners’ profit
                               - 12 -

objective does not depend merely upon the number of factors

satisfied.   See id.   As discussed above, petitioners bear the

burden of proof.   See Rule 142(a); Welch v. Helvering, 290 U.S.

111, 115 (1933).

     After careful consideration, we are not persuaded that

petitioners’ primary purpose for engaging in the sale and

distribution of Amway products was for income or profit.      The

manner in which petitioners conducted their Amway activity

virtually precluded any possibility of realizing a profit.       Cf.

Elliott v. Commissioner, 90 T.C. 960, 971-973 (1988), affd.

without published opinion 899 F.2d 18 (9th Cir. 1990).     For

example, petitioners freely incurred expenses with no realistic

plan for how they might recoup those expenses.     Although

petitioners maintained detailed records for certain aspects of

their distributorship, the records apparently were kept merely

for substantiation purposes rather than for use as tools to

increase the likelihood of profit.      See Hart v. Commissioner,

T.C. Memo. 1995-55; Poast v. Commissioner, T.C. Memo. 1994-399.

Furthermore, petitioners did not maintain the type of records

indicating that they had, for example, analyzed and confirmed the

existence of a potential market for their activity; established

how long it would take to recoup losses incurred during the early

years of their activity; or determined what level of sales would

be necessary for their activity to become profitable.
                                - 13 -

Considering their practice of recruiting only family, friends,

and acquaintances to be downline distributors, petitioners’

goal of achieving a monthly point value of 4,000, which they

considered to be the break-even point, strikes us as unrealistic,

at best.    Despite 4 years of losses, petitioners failed to change

tactics to increase the likelihood of earning a profit.

     Petitioners had no prior experience in business and no prior

experience as Amway distributors.     They accepted the advice of

upline distributors who stood to benefit by petitioners’

participation in an Amway distributorship but failed to solicit

advice from independent business advisers.     See Ogden v.

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

2001).     When they received unsolicited advice from their

accountant, they rejected it.     Petitioners’ restrictive method

of recruiting downline distributors continued from year to year

regardless of the ineffectiveness of that method.

     During the years in issue, Jorge Lopez continued his full-

time employment as an engineer.     Consequently, petitioners’

ability to maintain their financial status did not depend on the

profitability of their Amway distributorship.     It also appears

that a substantial portion of the time petitioners spent on their

Amway activity involved socializing with family and friends.

See Connor-Nissley v. Commissioner, T.C. Memo. 2000-178.
                             - 14 -

     Having considered all of the relevant facts and

circumstances, we conclude that petitioners are not entitled

to the deductions here in dispute because their Amway

distributorship was not a trade or business within the meaning

of section 162(a) for either year in issue.   Respondent’s

determinations in this regard are, therefore, sustained.

     To reflect the foregoing,

                                        Decision will be

                                   entered for respondent.
