                       T.C. Memo. 1999-403



                     UNITED STATES TAX COURT



                 TIMOTHY KLUSKEN, Petitioner v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent


     Docket No. 13482-98.                  Filed December 13, 1999.


     Timothy Klusken, pro se.

     Ric D. Hulshoff, for respondent.


                       MEMORANDUM OPINION


     NAMEROFF, Special Trial Judge:     Respondent determined a

deficiency in petitioner’s 1996 Federal income tax of $2,404.

Unless otherwise indicated, section references are to the

Internal Revenue Code in effect for the year in issue.

     The issues for decision are:   (1) Whether petitioner is

liable for self-employment tax on amounts that he received from

Strategic Telecom Systems, Inc. (Strategic); and (2) whether

petitioner is entitled to deductions greater than the amount
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claimed on Schedule C and allowed by respondent in the notice of

deficiency.1

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

The written stipulation of facts and supplemental stipulation of

facts, with the attached exhibits, and the oral stipulation are

incorporated herein by this reference.     At the time the petition

was filed, petitioner resided in Los Angeles, California.

     During the year at issue, petitioner became involved with

Strategic, a company which sells prepaid phone cards.     Strategic

operates a multilevel marketing arrangement wherein a sponsor

recruits downline distributors, who then recruit additional

representatives beneath them.     The upline distributors earn

commissions on the sales generated by those below them.     This is

typically known as a “pyramid” system.

     On February 7, 1996, petitioner signed an “Independent

Representative Application and Agreement” (agreement) with

Strategic.     In signing the agreement, petitioner became eligible

to sell and distribute Strategic’s goods and services and to

receive commissions in connection with such sales.     Petitioner

also agreed that he “is an independent contractor not an agent,

employee or franchisee of the Company” and that he will not be


     1
        At trial, counsel for respondent questioned the
substantiation of expenses petitioner claimed on his Schedule C.
We note that in the notice of deficiency all of petitioner’s
claimed expenses were allowed, and we do not examine the
substantiation of those items.
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treated as an employee of Strategic “for federal or state tax

purposes”.   Petitioner agreed therein that he “will pay all

applicable federal and state income taxes, self-employment taxes,

sales taxes, local taxes, and/or local license taxes”.   It is

also stated in the agreement that “remuneration will consist

solely of commissions, overrides and/or bonuses relating to the

sales or other output derived from in-person sales, solicitations

or orders from ultimate consumers”.

     On February 10, 1996, petitioner’s mother, on behalf of

petitioner, purchased a money order payable to Strategic for

$328.14.   This was the cost to initiate a distributorship with

Strategic.   Petitioner’s sponsor (or upline distributor) was Luan

Schaff-Hahn (Ms. Schaff-Hahn).

     There were downline independent representatives assigned to

be below petitioner, and he received periodic checks from sales

generated downline.   Petitioner also received commission reports.

Petitioner received a Form 1099-MISC for tax year 1996 from

Strategic showing that he received $19,200 as nonemployee

compensation and $1,155 for prizes and awards.   Petitioner

reported this income on Schedule C filed with his 1996 return.

     The parties orally stipulated that petitioner was not an

employee of Strategic at any time, did not lend funds to

Strategic, and never purchased or held stock of Strategic.     The

parties orally further stipulated that the amounts petitioner
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received from Strategic did not constitute compensation for

employment or for any employment-related activities, nor were

they repayments of funds or dividends issued with respect to

stock.

     Petitioner also claimed expenses of $567.99 on Schedule C

which consisted of $67.35 for Internet access fees, $157.50 for

maintenance dues, $15 for postage, and $328.14 for the startup

kit/initiation fee.   As a result, petitioner reported a net

profit of $19,787.

     In the notice of deficiency, respondent determined that

petitioner was liable for self-employment tax (and entitled to

the self-employment tax deduction) on $19,787.

     Petitioner contends that he is not liable for self-

employment tax since he was not involved in this activity with

continuity and regularity.   Petitioner argues that he did not

sell any of Strategic’s product and that he did not recruit any

downline distributors.   He claims that Ms. Schaff-Hahn or someone

above her recruited the downline distributors and placed them

below petitioner.

     Additionally, petitioner contends that he paid maintenance

fees of roughly $75 per month to maintain his distributorship.

Petitioner authorized Strategic to charge his credit card monthly

in exchange for a “Monthly Collector Series Single IRC”, which

petitioner testified was a collector’s phone card.   Petitioner
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claimed a Schedule C deduction of $157.50 for 2 months of these

maintenance fees but alleged that he paid this fee every month in

1996.   We held the record open for 45 days to allow petitioner to

provide documentation to substantiate any additional expense.

Petitioner provided two credit card statements that show he paid

a total of $157.50 to Strategic.   Petitioner also provided a

packing list which shows that Strategic sent a product to

petitioner in November 1996 in connection with the “Automatic

Monthly Reorder” petitioner authorized.   Petitioner did not

provide any further documentation.

     Section 1401 imposes a tax on a taxpayer’s self-employment

income.   Self-employment income includes the net earnings from

self-employment derived by an individual during the taxable year.

See sec. 1402(b).   Net earnings from self-employment income means

gross income derived by an individual from any trade or business

carried on by the individual, less any attributable deductions.

See sec. 1402(a).   An individual is engaged in a trade or

business if the individual’s activities are conducted with

continuity and regularity and primarily for income or profit.

See sec. 1402(c); Commissioner v. Groetzinger, 480 U.S. 23, 35

(1987).   The trade or business may be carried on by an individual

“either personally or through agents or employees.”   Sec.

1.1402(a)-2(b), Income Tax Regs.
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       Petitioner contends that he did not perform any services for

Strategic during 1996, and that therefore there was no continuity

or regularity in the activity.    Petitioner may not have performed

any sales or recruiting activities himself during 1996;

nonetheless, sales activities were performed by petitioner’s

downline representatives, and the income that petitioner received

was derived from those activities.       As we understand Strategic’s

sales structure, the representatives performing the sales

activity were petitioner’s agents.       Therefore, there was

continuity and regularity in sales from which petitioner

benefited, and the income petitioner received was derived from a

trade or business.    See Abraham v. Commissioner, T.C. Memo. 1988-

412.    Accordingly, we hold that petitioner is liable for self-

employment tax on the net income earned from Strategic.

       We next consider whether petitioner is entitled to deduct

any additional $75 monthly fees allegedly paid for the

collector’s phone card.    Section 162(a) allows a deduction for

the ordinary and necessary expenses paid or incurred during the

taxable year in carrying on a trade or business.       It is not clear

from the record whether this fee was mandatory to maintain the

distributorship.    The terms of the agreement specifically state

that petitioner is not required to purchase Strategic’s products

after the initial purchase of the startup sales kit.       Petitioner

has not established that the collector’s phone card fee was an
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ordinary and necessary expense of his business.     Rather, it

appears that petitioner was purchasing a product.        In any event,

petitioner did not substantiate any amount of expenditure greater

than the amounts claimed on the return and not disallowed in the

notice of deficiency.   Therefore, petitioner is not entitled to a

deduction for these purchases.2

     On the basis on the foregoing,

                                            Decision will be entered

                                       for respondent.




     2
        The record contains a document that    shows that petitioner
paid $29 to Strategic on Dec. 30, 1996, for    “Annual Renewal”.
Petitioner stated that this was for renewal    of the
distributorship. This amount is de minimis     and will not affect
the tax computation, even if not originally    claimed.
