                                  T.C. Memo. 2013-271



                            UNITED STATES TAX COURT



    CHRISTINE C. PETERSON AND ROGER V. PETERSON, Petitioners v.
         COMMISSIONER OF INTERNAL REVENUE, Respondent



      Docket Nos. 16263-11, 2068-12.                 Filed November 25, 2013.



      Mitchell I. Horowitz and Micah G. Fogarty, for petitioners.

      Andrew M. Tiktin and Timothy A. Sloane, for respondent.



               MEMORANDUM FINDINGS OF FACT AND OPINION


      FOLEY, Judge: After concessions, the issues for decision are: (1) whether

retirement plan contributions of $275,365, $312,266, and $173,500 relating to

2006, 2007, and 2008, respectively, are deductible pursuant to section 404(a);1 and


      1
          Unless otherwise indicated, all section references are to the Internal
                                                                           (continued...)
                                          -2-

[*2] (2) whether distributions petitioners received during 2009 are subject to self-

employment tax pursuant to section 1401.

                                 FINDINGS OF FACT

      In 1982, Mrs. Peterson began working as an independent beauty consultant

for Mary Kay, Inc. (Mary Kay). Mrs. Peterson sold Mary Kay products2 and

recruited other individuals to join the company. She was extremely successful

and, on July 1, 1991, entered into a national sales director3 (NSD) agreement with

Mary Kay. Mrs. Peterson earned commissions on wholesale purchases of Mary

Kay products by her network of independent beauty consultants, sales directors,

and NSDs.

      On November 12, 1992, and July 1, 2005, Mrs. Peterson and Mary Kay

entered into a Family Security Program (FSP) agreement and a Great Futures

Program (GFP) agreement, respectively.4 Both agreements provided that Mary


      1
      (...continued)
Revenue Code in effect for the years in issue, and all Rule references are to the
Tax Court Rules of Practice and Procedure.
      2
        Mary Kay is a wholesale distributor of cosmetics, toiletries, skin care, and
related products.
      3
          National sales director is the highest Mary Kay sales position.
      4
          Mary Kay had the authority to “amend, modify or terminate” either
                                                                      (continued...)
                                        -3-

[*3] Kay would make distributions to Mrs. Peterson after her completion of five

years of NSD service and retirement from the company. Pursuant to the FSP

agreement, Mrs. Peterson was entitled to a monthly distribution based on an

“Applicable Percentage” of her “Final Average Commissions” (i.e., an average of

her three highest commission years during the five years prior to her retirement).

Pursuant to the GFP agreement, Mrs. Peterson was entitled to a monthly

distribution based on an “Applicable Percentage” of certain prospective wholesale

purchases. The “Applicable Percentage” pursuant to both agreements was based

on Mrs. Peterson’s age at retirement. Effective December 31, 2008, Mary Kay

amended the FSP and the GFP agreements to expressly provide that each program

was “intended to be a non-qualified deferred compensation arrangement” and was

“intended to meet the requirements of Section 409A of the Code and shall be

construed and interpreted in accordance with such intent.”

      Petitioners, on April 1, 2000, entered into the Christine Peterson Defined

Benefit Plan and Trust (CP Plan), designated themselves as trustees, and

designated Mrs. Peterson as the employer. In December 2002, petitioners formed

NSD Interests, L.P. (NSD Interests) a Georgia limited partnership. Petitioners


      4
      (...continued)
agreement “at any time and in any manner.”
                                        -4-

[*4] were limited partners of NSD Interests, and their wholly owned entity was the

general partner. Mrs. Peterson attempted to assign her Mary Kay commissions to

NSD Interests. The assignment, however, was ineffective because Mary Kay did

not consent. On December 29, 2003, NSD Interests entered into an adoption

agreement relating to the NSD Interests, L.P., Defined Benefit Plan and Trust

(NSD Plan). The adoption agreement provided that it was “an amendment and

restatement of a previously established qualified plan of the Employer which was

originally effective January 1, 2000” (i.e., the CP Plan). The NSD Plan designated

NSD Interests as the employer and petitioners as trustees.

      Mrs. Peterson received nonemployee compensation from Mary Kay of

$750,127, $799,191, and $892,543 relating to 2006, 2007, and 2008, respectively.

In 2009, Mrs. Peterson retired from Mary Kay and received nonemployee

compensation pursuant to the FSP and the GFP agreements of $489,707.

Petitioners timely filed their 2006, 2007, 2008, and 2009 (years in issue) Federal

income tax returns. On Schedules C, Profit or Loss From Business, petitioners

reported “Other Expenses” equaling Mrs. Peterson’s nonemployee compensation.

NSD Interests timely filed Federal income tax returns relating to the years in issue

and reported gross receipts of $750,127, $799,191, $892,543, and $489,707 (i.e.,

the same amounts reported on petitioners’ Schedules C). NSD Interests claimed
                                        -5-

[*5] deductions of $275,365, $312,266, and $173,500 for retirement contributions

to the NSD Plan relating to 2006, 2007, and 2008, respectively.

      Respondent, on April 7, 2011, sent petitioners a notice of deficiency relating

to 2006 and 2007 and on October 18, 2011, sent petitioners a notice of deficiency

relating to 2008 and 2009 (collectively, notices). In the notices, respondent

determined that petitioners were subject to self-employment tax relating to their

distributive shares of net partnership income reported by NSD Interests and were

liable, pursuant to section 6662(a), for accuracy-related penalties. On July 11,

2011, and January 23, 2012, petitioners, while residing in Florida, timely filed

petitions with the Court. In amendments to answers filed on August 30 and

December 13, 2012, respondent determined that NSD Interests was not engaged in

a trade or business during the years in issue; deductions claimed by NSD Interests

were not ordinary and necessary expenses; NSD Interests was disregarded as a

partnership for Federal income tax purposes; all items of income reported by NSD

Interests were properly allocable to Mrs. Peterson; NSD Interests did not qualify

as an employer pursuant to section 401(c)(4); and Mrs. Peterson’s nonemployee

Mary Kay compensation was subject to self-employment tax. After concessions,

the remaining issues for decision are whether retirement plan contributions that

NSD Interests made relating to 2006, 2007, and 2008 are deductible pursuant to
                                        -6-

[*6] section 404(a); and whether distributions petitioners received during 2009,

pursuant to the FSP and the GFP agreements, are subject to self-employment tax.

                                     OPINION

      Respondent contends that NSD Interests was not engaged in a trade or

business and therefore was not, pursuant to section 404(a), entitled to deduct

contributions to the NSD plan. Respondent bears the burden of proof because he

raised this theory for the first time in his amendments to answers. See Rule 142.

NSD Interests’ contributions may be deductible pursuant to section 404(a) if they

are “expenses which would be deductible under section 162 (relating to trade or

business expenses) or 212 (relating to expenses for production of income)”, but

“only to the extent that they are ordinary and necessary expenses”. See sec.

404(a); sec. 1.404(a)-1(b), Income Tax Regs. “A partnership activity does not

constitute a trade or business unless the partnership engages in the activity with

the predominant purpose and intention of making a profit.” Flowers v.

Commissioner, 80 T.C. 914, 931 (1983). In determining whether NSD Interests

was engaged in a trade or business, all relevant facts and circumstances must be

taken into account. See Surloff v. Commissioner, 81 T.C. 210, 233 (1983).

      Petitioners concede that NSD Interests “was not engaged in a trade or

business in 2008 * * * and was merely the passive recipient of income”. Mrs.
                                         -7-

[*7] Peterson readily acknowledged that NSD Interests was merely a “structure” to

hold her Mary Kay earnings and that it was created “for the tax savings”.

Furthermore, petitioners concede that during 2006, 2007, and 2008, NSD Interests

had no income and that the income reported on its returns should have been

reported on petitioners’ returns. In sum, NSD Interests was not engaged in a trade

or business during 2006, 2007, and 2008. See Flowers v. Commissioner, 80 T.C.

at 931; Hager v. Commissioner, 76 T.C. 759, 784-785 (1981). Accordingly, NSD

Interests is not entitled to deduct retirement plan contributions relating to these

years. See sec. 404(a); Surloff v. Commissioner, 81 T.C. at 240; sec. 1.404(a)-

1(b), Income Tax Regs.

      Respondent further contends that Mrs. Peterson was not an employer and

therefore is not, pursuant to section 404(a), entitled to deduct retirement

contributions to the NSD plan. Respondent concedes that the NSD plan is valid;

Mrs. Peterson “was engaged in carrying on a Mary Kay business during the

taxable years 2006, 2007, and 2008”; and certain “expenses that were originally

reported on the Form 1065 for NSD Interests are allowable as deductions and are

reportable on Schedule[s] C of petitioners’ Form[s] 1040”. Mrs. Peterson formed
                                        -8-

[*8] the CP Plan and was designated as the employer5 pursuant to it. On

December 29, 2003, NSD Interests amended and restated the CP Plan. The NSD

Plan defined an “Employer” as “the entity specified in the Adoption Agreement,

any successor which shall maintain this Plan and any predecessor which has

maintained this Plan.” Mrs. Peterson (i.e., a predecessor who maintained the plan)

was an “Employer” pursuant to the NSD Plan, and the retirement contributions

were “expenses which would be deductible under section 162”. See sec. 1.404(a)-

1(b), Income Tax Regs. Accordingly, Mrs. Peterson is entitled to deduct, pursuant

to section 404(a), the retirement contributions relating to 2006, 2007, and 2008.

      Petitioners contend that the distributions they received during 2009 pursuant

to the FSP and the GFP agreements are not subject to self-employment tax. We

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

Self-employment income consists of gross income derived by an individual from

any trade or business carried on by that individual. See sec. 1402(a) and (b). Mrs.

Peterson formerly carried on a trade or business. Therefore, Mary Kay’s 2009

distributions pursuant to the FSP and the GFP agreements are subject to self-

employment tax if they were “derived” from Mrs. Peterson’s business (i.e.,“‘tied


      5
       Pursuant to sec. 401(c)(4), “An individual who owns the entire interest in
an unincorporated trade or business shall be treated as his own employer.”
                                         -9-

[*9] to the quantity or quality of * * * [her] prior labor’”). See Jackson v.

Commissioner, 108 T.C. 130, 135-136 (1997) (quoting Milligan v. Commissioner,

38 F.3d 1094, 1098 (9th Cir. 1994), rev’g T.C. Memo. 1992-655). The Mary Kay

distributions were “tied to” the quantity and quality of Mrs. Peterson’s prior labor.

See id. Pursuant to the FSP agreement, Mrs. Peterson’s distributions were based

on her average commissions over the five years prior to her retirement. Pursuant

to the GFP agreement, Mrs. Peterson’s distributions were based on the

postretirement wholesale volume of her network (i.e., how well the network

performed based on her prior services). In addition, Mary Kay’s distributions

pursuant to both plans were based on Mrs. Peterson’s age at retirement and

minimum years of service. Moreover, the FSP and the GFP agreements expressly

provided that the distributions were deferred compensation (i.e., related to Mrs.

Peterson’s prior labor). Petitioners failed to adduce proof sufficient to alter the

construction of these unambiguous agreements or show that they were

unenforceable. See Plante v. Commissioner, 168 F.3d 1279, 1280-1281 (11th Cir.

1999), aff’g T.C. Memo. 1997-386; Commissioner v. Danielson, 378 F.2d 771,

775 (3d Cir. 1967), vacating and remanding 44 T.C. 549 (1965). Accordingly, the

2009 FSP and GFP distributions are subject to self-employment tax pursuant to

section 1401.
                                      - 10 -

[*10] Contentions we have not addressed are irrelevant, moot, or meritless.

      To reflect the foregoing,



                                                    Decisions will be entered under

                                               Rule 155.
