                  T.C. Summary Opinion 2003-88



                     UNITED STATES TAX COURT



  JOE GUADAGNO AND SUSAN BETH RISHEL GUADAGNO, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 10312-01S.            Filed July 9, 2003.



     Joe Guadagno and Susan Beth Rishel Guadagno, pro sese.

     T. Keith Fogg, for respondent.



     CARLUZZO, 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.   Unless otherwise

indicated, subsequent section references are to the Internal

Revenue Code in effect for the years in issue.   The decision to

be entered is not reviewable by any other court, and this opinion

should not be cited as authority.
                                - 2 -

     Respondent determined deficiencies in petitioners’ Federal

income taxes of $3,976, $3,790, and $5,420 for 1996, 1997, and

1998, respectively.    The issue for decision for each year is

whether petitioners are entitled to deductions for expenses

incurred in connection with the sale and 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.

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 Fredericksburg,

Virginia.

     At all relevant times Joe Guadagno was an officer in

the U.S. Marine Corps.    Through June 1996, and then again

from December 1996 through February 1997, Susan Guadagno was

employed full time as a systems analyst by Systems Maintenance &

Technology, Inc.

     Toward the end of 1995, while living in North Carolina,

petitioners were contacted by a distributor of Amway products;

soon thereafter they became users and distributors of Amway

products.    Petitioners moved to Virginia in 1998.   They continued

to use and distribute Amway products throughout the years in
                               - 3 -

issue.   In September 1999, petitioners ceased their Amway

activity and became involved in Quixtar, Inc., an Amway

affiliate.

     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

primarily to “downline”1 distributors and customers.2   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 its products is approximately

25-30 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.




     1
       The term “downline” 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.
     2
       A customer purchases Amway products for personal
consumption, but a distributor purchases Amway products intending
to resell them to customers or other distributors.
                               - 4 -

     Amway has about 360,000 independent distributors.    During

the years in issue, an Amway distributor’s average monthly gross

income from Amway-related activities was less than $90.    Amway

does not assign its distributors exclusive territories.    As best

we can determine from the record, there is no contractual

relationship between an upline distributor and his or her

downline distributors.   A downline distributor is not obligated

to remain in the distribution network of an upline distributor

and is not obligated to achieve any minimum sales levels.

     A distributor’s performance bonus is determined by his or

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

that corresponds to a particular tier in the Amway “performance

bonus schedule”.   Business volume is a dollar amount generally

equal to 87 percent of the suggested retail 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.3   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




     3
       According to petitioners’ exhibits, the ratio of business
volume to point value ranges from 2.00 to 2.62.
                               - 5 -

bonus schedule and corresponds to the distributor’s monthly point

value.4   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 1995.   They had no prior experience with Amway and no

prior experience running a business.    Before becoming Amway

distributors, petitioners received advice from other Amway

distributors but did not solicit business advice from those

outside the Amway community; nor did petitioners seek independent

business advice during the course of their affiliation with

Amway.

     During the years in issue, petitioners spent little time or

effort attempting to sell Amway products; instead they intended

to develop a network of distributors.    Consequently, their

potential for profit depended almost entirely on 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.    In this


     4
       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.
                                - 6 -

regard, petitioners compiled an extensive list of family members,

friends, and acquaintances that they used to identify and recruit

potential downline Amway distributors.   Typically, petitioners

made contact with these individuals either by telephone or by

traveling to wherever these individuals lived to meet with them.

Nothing in the record suggests that petitioners made any effort

to develop a profile of a successful downline distributor on

which basis they would recruit; instead, petitioners recruited

family, friends, and acquaintances.

     Petitioners’ attempts to recruit downline distributors also

consisted of describing the Amway business plan to friends and

acquaintances at gatherings in petitioners’ home or at

restaurants where food and beverages were routinely consumed.

Petitioners recruited 26 downline distributors in 1996, 37 in

1997, and 12 in 1998.   The record does not disclose how many, if

any, of these downline distributors were in a familial or

preexisting social relationship with petitioners.

     The relationship between petitioners and their downline

distributors was, at best, informal.    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
                                 - 7 -

presumably had to compete with some of the roughly 360,000 Amway

distributors 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.

     Included with petitioners’ timely filed return for each

year is a Schedule C, Profit or Loss From Business.     Each

return was prepared by a certified public account who also was

an Amway distributor.    Petitioners’ Schedules C for 1996 and

1997 list their principal business as “Amway”.     For 1998,

petitioners’ Schedule C lists their principal business as

“DistConsumerProduct”.    Petitioners reported net losses of

$26,264, $24,047, and $19,810 on their Schedules C for 1996,

1997, and 1998, respectively.5



     5
       From petitioners’ trial presentation, it appears to us
that, technically, petitioners conducted their Amway
distributorship as a partnership, the income and expenses of
which are not properly reportable on a Schedule C, Profit or Loss
From a Sole Proprietorship, under any circumstance. See secs.
701 through 777. Nevertheless, because the parties ignored this
technicality, we do likewise.
                                - 8 -

     In the notice of deficiency, respondent disallowed the

losses claimed on the Schedules C.      Other adjustments made in the

notice of deficiency either give effect to these disallowances or

are not in dispute.

Discussion

     According to petitioners, their Amway activity, at

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

petitioners argue that the expenses they incurred in carrying

on this activity should be allowed as deductions.     See sec.

162(a) (generally allowing deductions for the ordinary and

necessary expenses paid or incurred during the taxable year in

carrying on any trade or business).     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 183.6    For the following reasons, we



     6
         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...)
                               - 9 -

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 an 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

     6
      (...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).
                              - 10 -

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; 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

statement of intent.   See Engdahl v. Commissioner, 72 T.C. 659,

666 (1979); sec. 1.183-2(a), Income Tax Regs.

     The following nonexclusive factors are considered 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, and our

conclusion with respect to petitioners’ profit objective does not
                              - 11 -

result merely from comparing the number of factors that suggest a

profit motive against the number of factors that suggest the

opposite.   See sec. 1.183-2(b), Income Tax Regs.

     After careful consideration, we are satisfied that

petitioners did not engage in the sale and distribution of Amway

products with the profit objective necessary for that activity to

be considered a trade or business within the meaning of section

162 during any of the years in issue.7   Our conclusion in this

regard is particularly influenced by the following.

     Before becoming Amway distributors, petitioners had neither

experience with Amway nor experience in running a business.

Nevertheless, they did not seek independent business advice at

the outset, and they did not seek independent business advice

afterwards even though losses were sustained year after year.

Instead, they relied upon other Amway distributors whose advice

is more accurately characterized as personal motivational advice

than strategic business advice.   Under the circumstances,

petitioners’ failure to seek independent business advice strongly

suggests that they were distributing and using Amway products for

purposes other than profit.   See Ogden v. Commissioner, T.C.

Memo. 1999-397, affd. 244 F.3d 970 (5th Cir. 2001).



     7
       Although neither party specifically addressed the point,
our analysis presumes that respondent bears the burden of proof.
See sec. 7491(a).
                              - 12 -

     Petitioners’ Amway activity has resulted in substantial

losses.   Losses that are incurred in the initial stages of an

activity do not necessarily suggest the absence of an honest

profit objective.   However, losses that continue without

explanation beyond that period typically required for an activity

to become profitable may indicate the lack of a profit objective.

See Golanty v. Commissioner, supra at 427; Conner-Nissley v.

Commissioner, T.C. Memo. 2000-178; Ogden v. Commissioner, supra.

Despite year after year of losses, petitioners did not change

tactics to increase the likelihood of earning a profit.

     For the most part, the losses that petitioners incurred year

after year are attributable to automobile and travel expenses

(including the expenses incurred in attending various seminars).

Petitioners did not concentrate on selling Amway products to

customers, thereby eliminating sales as a potential source of

profit.   A substantial portion of the income earned from bonuses

they received each year was paid out to their downline

distributors.   Other components of income were completely offset

by matching expenses for the same items.   Against the slim margin

for profit, petitioners haphazardly incurred significant

expenditures for automobile and other travel expenses in order to

recruit downline distributors primarily from the ranks of family,

friends, and acquaintances, some of whom lived considerable
                                - 13 -

distances from petitioners.   Such behavior suggests the absence

of a profit objective.   See Bessenyey v. Commissioner, supra.

     Although petitioners maintained detailed records for certain

aspects of their distributorship, the records apparently were

kept more for substantiation purposes than for use as analytical

business tools.   See Theisen v. Commissioner, T.C. Memo. 1997-

539; Hart v. Commissioner, T.C. Memo. 1995-55; Poast v.

Commissioner, T.C. Memo. 1994-399.

     In closing, we note that even if petitioners had maintained

their monthly point value goal of 4,000, their expenses would

still have exceeded their income from performance bonuses and

retail sales.

     We are satisfied that petitioners’ primary purpose for

engaging in the sale and distribution of Amway products was

not for income or profit.   After consideration of all of the

facts and circumstances, we find that petitioners’ Amway

distributorship does not fit within “a common-sense concept of

what is a trade or business.”    Commissioner v. Groetzinger, 480

U.S. at 35.   Therefore, petitioners are not entitled to the

deductions here in dispute, and respondent’s determination in

this regard is sustained.

     Reviewed and adopted as the report of the Small Tax

Division.
                        - 14 -

To reflect the foregoing,

                                  Decision will be

                             entered for respondent.
