                        T.C. Memo. 1997-539



                      UNITED STATES TAX COURT



          KENNETH C. & BECKY J. THEISEN, Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 9759-96.                     Filed December 8, 1997.



     Rory Alan Boatright, for petitioner.

     Franklin R. Hise, for respondent.



                        MEMORANDUM OPINION

     PAJAK, Special Trial Judge:   This case was heard pursuant to

section 7443A(b)(3) of the Code and Rules 180, 181, and 182.     All

section references are to the Internal Revenue Code in effect for

the years in issue.   All Rule references are to the Tax Court

Rules of Practice and Procedure.
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     Respondent determined deficiencies in petitioners' Federal

income taxes as follows:

               Year            Deficiency
               1992              $3,160
               1993               4,240

In the notice of deficiency, respondent disallowed petitioners'

deductions for Schedule C expenses incurred in connection with

their Amway activity because they were not ordinary and necessary

expenses within the meaning of section 162.   By answer,

respondent raised the issue that petitioners did not intend to

make a profit from their Schedule C activities for 1992 and 1993.

In the answer, respondent also requested the Court to find that

the deficiencies in tax for 1992 and 1993 were subject to the

accuracy-related penalties under section 6662.   Respondent's

answer further asserted that petitioners were negligent and

intentionally disregarded the rules or regulations under the

Internal Revenue Code in filing their 1992 and 1993 Federal

income tax returns.

     Respondent has conceded that petitioners did not have a

substantial understatement of income tax for 1992 and 1993 under

section 6662(d).   As a result of the concession, the parties

limited the issue of penalties to those under section 6662(b)(1)

as follows:

               Year            Penalty
               1992             $632
               1993              848
                                 -3-


     The issues remaining for decision are: (1) Whether

respondent proved that petitioners did not engage in their Amway

activity for profit within the meaning of section 183; (2) if

not, whether petitioners proved they are entitled to deduct

expenses in carrying out the Amway activity as ordinary and

necessary expenses under section 162; and (3) whether respondent

proved that petitioners are liable for the accuracy-related

penalties under section 6662(b)(1).

     The facts as stipulated are so found.   The stipulation of

facts and attached exhibits are incorporated herein by this

reference.

     Petitioners resided in Austin, Texas, at the time they filed

their petition.   For convenience and clarity, we have combined

the findings of fact and opinion.

     Petitioner Kenneth C. Theisen (petitioner) was employed full

time by the Internal Revenue Service (Service) as a revenue agent

during the years in issue.   He had been so employed for the past

10 years.    He has a Bachelor of Science in Accounting and is a

Certified Public Accountant.   During 1992 and 1993, petitioner

Becky J. Theisen was employed as a travel agent.   Petitioners

were the parents of two children.

     Petitioners had been Amway distributors in 1979 and 1980.

Petitioners again became Amway distributors in 1991, and were

distributors during 1992 and 1993, the years in issue, and at
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least up to the date of trial.    During the years in issue,

petitioner claimed that he participated in the Amway activity on

an average of 15-20 hours per week.    Mrs. Theisen claimed that

she participated in the Amway activity with her husband on an

average of 4 hours per week.    She stated that her primary

function was doing the paperwork and visiting with wives of

prospective distributors of Amway products.

     Amway is a supplier of various household products.    It sells

these products via marketing through distributors, such as

petitioners.   Distributors purchase the products for personal

use, as well as for resale to customers and downline distributors

(also known as "downliners").    Distributors are encouraged to

recruit others to become downline distributors.    The Amway system

is based on a pyramid system whereby a distributor's direct and

indirect sales are rewarded with bonuses.

     Petitioners filed joint Federal income tax returns for 1992

and 1993.   On Schedules C of these returns, petitioners claimed

net losses in the amounts of $11,074 and $14,881, for 1992 and

1993, respectively, from Theisen Enterprises.

     Theisen Enterprises is petitioners' sole proprietorship.

Petitioners claim that Theisen Enterprises is engaged in the

business of selling Amway products.    On Schedule C of each

return, line B, "principal business code", petitioners listed

"3012", which number represents "Selling door to door, by
                                -5-


telephone or party plan, or from mobile unit".     On their Federal

income tax returns for the years in issue, petitioners did not

disclose that they or Theisen Enterprises were engaged in an

Amway activity.   In fact, on both returns, line A of Schedule C,

"Principal business or profession, including product or service",

was left blank.

     Deductions are a matter of legislative grace.      New Colonial

Ice Co. v. Helvering, 292 U.S. 435, 440 (1934).      Respondent's

determinations are presumed correct, and petitioners bear the

burden of proving otherwise.   Rule 142(a); Welch v. Helvering,

290 U.S. 111, 115 (1933).   However, respondent bears the burden

for any new matter pleaded in the answer.      Rule 142(a).

Petitioner made a motion to that effect as to the section 183

issue, and the Court granted it.      Respondent acknowledged the

burden of proof as to the section 6662(b)(1) issue for both

years.

     Section 183(a) disallows any deductions attributable to

activities not engaged in for profit except as provided under

section 183(b).   Taxpayers need not have a reasonable expectation

of profit.   However, the facts and circumstances must demonstrate

that they entered into the activity, or continued the activity,

with the actual and honest objective of making a profit.      Taube

v. Commissioner, 88 T.C. 464, 478 (1987); Dreicer v.

Commissioner, 78 T.C. 642, 645 (1982), affd. without opinion 702
                                -6-


F.2d 1205 (D.C. Cir. 1983); sec. 1.183-2(a), Income Tax Regs.

The taxpayer's motive to make a profit must be analyzed by

looking at all the surrounding objective facts.   Dreicer v.

Commissioner, supra at 645.   These facts are given greater weight

than to petitioners' mere statement of intent.    Dreicer v.

Commissioner, supra.

     Section 1.183-2(b), Income Tax Regs., provides a

nonexclusive list of relevant factors to be considered in

deciding whether an activity is engaged in for profit.   These

factors are: (1) The manner in which the taxpayer carries on the

activity; (2) the expertise of the taxpayer or his advisors; (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 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.   Sec. 1.183-2(b), Income Tax Regs.    These

factors are not applicable or appropriate in every case.

Abramson v. Commissioner, 86 T.C. 360, 371 (1986).

     After a review of the record, we conclude that respondent

has carried the burden of proving that petitioners lacked the

requisite profit objective within the meaning of section 183 in
                                  -7-


operating their Amway activity.     Petitioners' Amway activity

resulted in a net loss for taxable years 1992 and 1993.     Although

it is not unusual for a business to incur losses in its early

years, we believe that petitioners never had any intention of

making a profit from this activity.

     Petitioners contend that their Amway activity was motivated

by profit.   Petitioners averred that they carried on their Amway

activity in a businesslike manner, maintained complete and

accurate financial records and books, studied the market and

strategies of others, attended seminars, and conformed their

sales techniques with more successful approaches.     However, the

record indicates that petitioners did not operate in a

businesslike manner.   Petitioners did not have a business plan,

nor did they conduct a break-even analysis.     Petitioners had no

budget.

     Petitioner candidly admitted in court that one of the major

benefits of being an Amway distributor was that such distributors

could purchase various products for personal use at a discount of

15 to 50 percent, if not more.    He further stated that the

opportunity to purchase discounted products was a benefit.      His

testimony evidenced that petitioners used their Amway

distributorship for their own personal financial gain.     He

stressed this benefit when he made sales pitches in his attempts

to recruit potential downliners.
                                -8-


     When questioned whether his downliners sell the products,

petitioner testified:

     Generally, no. The way the plan is written is, you're
     taught to purchase things from yourself for yourself, and
     you get other people -- say, Look. Just change your buying
     habits. Don't go to HEB. Don't go to Eckerd's. Don't go
     to Sam's. You get access to all these products. Change
     your buying habits. Buy things for yourself.

     Petitioner also conceded that petitioners' personal

purchases were more than the purchases they acquired for resale

to other customers or downline distributors.   Specifically,

petitioner admitted that in 1992 he bought $4,500 of products for

personal use and $3,262 of products for other purposes.    For

1993, he conceded he bought $10,729 of products for personal use

and $4,991 of products for other purposes.

     Petitioners have consistently reported tax losses on their

Amway activity.   Although only taxable years 1992 and 1993 are at

issue here, petitioners have claimed net losses from their Amway

activity for taxable years 1991 through 1995, of $2,745.06,

$11,073.51, $14,881, $13,008, and $11,681, respectively.

     Petitioner could not explain with any detail or certainty

how or when the Amway activity would become profitable.    He could

not explain how many downliners he needed to recruit in order to

realize a profit.   Moreover, he stated that when downliners

purchased products through petitioners the purchases were at
                                -9-


cost.   Consequently, any opportunity for petitioners to make a

profit was limited to Amway bonuses.

     Petitioners claimed car and truck expenses in excess of the

gross receipts reported on their 1992 and 1993 Schedules C.    The

parties agreed that petitioners' 1992 vehicle expenses attributed

by petitioner on the returns to business use was 57 percent of

the total mileage.   In 1993, petitioners purchased a new vehicle

and claimed 70 percent of its expenses as business expenses on

the return.   Petitioners' 1992 ledger shows that 50 percent of

their telephone bill was attributed to business use, and the

other 50 percent was for personal use.   In 1993, that ratio

increased to 80 percent business use and 20 percent personal use.

Petitioner could not explain why there were such substantial

increases in vehicle and telephone expenses without a concomitant

increase in revenue.

     Petitioners contend that their detailed ledger of income and

expenses supports their position that their Amway activity was

motivated by profit.   Although a detailed ledger of income and

expenses is relevant, it appears that petitioners maintained

these records for substantiation purposes rather than to monitor

the income and expenses of their Amway activity.   As stated

repeatedly on the record, substantiation is not an issue in this

case.
                                - 10 -


     Petitioners' record-keeping is also not complete and

accurate.   In light of his position as a revenue agent for the

Service, petitioner must have realized that the absence of gross

income would tend to indicate that the activity lacked any profit

motive.   We believe that petitioner intentionally failed to

include the cost of motivational tapes in the calculation of

costs of goods sold in order to avoid disclosing a negative gross

income on the Schedule C for both years.    Petitioner admitted

that if these purchases had been included in costs of goods sold,

petitioners would not have had any gross income for those years.

We agree with respondent that these purchases should have been

included in the costs of goods sold.     Accordingly, we find that

petitioners did not have gross income in 1992 or 1993.

     We have considered petitioners' other arguments and find

that they are without merit.

     On this record, we find that petitioners did not have an

honest objective to make a profit in their Amway activity.

Petitioners operated this activity primarily because it allowed

them to purchase discounted merchandise for personal use, and it

enabled them to convert personal expenses to Schedule C

deductions.   Section 262 disallows any deduction for personal,

living, or family expenses.    Examination of their Schedules C for

both years shows that they were not entitled to claim any

deductions "otherwise allowable" pursuant to section 183(b)(1).
                                 - 11 -


Moreover, because there was no gross income in either 1992 or

1993, petitioners were not entitled to any deductions under

section 183(b)(2).   In sum, petitioners were not entitled to any

deductions from their Amway activity for 1992 and 1993.

     In view of our holding on the section 183 issue, we need not

address the section 162 issue.

     Section 6662(a) provides for an accuracy-related penalty in

the amount of 20 percent of the portion of an underpayment of tax

attributable to, among other things, negligence or disregard of

rules or regulations.   Sec. 6662(a) and (b)(1).    Negligence is

defined to include any failure to make a reasonable attempt to

comply with the provisions of the Internal Revenue laws.       Sec.

6662(c); sec. 1.6662-3(b)(1), Income Tax Regs.     Moreover,

negligence is the failure to exercise due care or the failure to

do what a reasonable and prudent person would do under the

circumstances.   Neely v. Commissioner, 85 T.C. 934, 947 (1985).

Disregard is defined to include any careless, reckless, or

intentional disregard of rules or regulations.     Sec. 6662(c);

sec. 1.6662-3(b)(2), Income Tax Regs.

     Respondent also has met the burden of proof on this issue.

Petitioner possesses an accounting degree, is a Certified Public

Accountant, and has been a revenue agent with the Service for the

past 10 years.   Given his experience and extensive background in

tax-related matters, it is apparent that petitioner failed to
                                 - 12 -


exercise due care and disregarded the Internal Revenue laws when

he claimed personal expenses as business deductions.        Therefore,

we find petitioners liable for the penalties under section

6662(b)(1) for 1992 and 1993.

     To reflect the foregoing,

                                               Decision will be entered

                                          for respondent.
